Government plans for pension flexibility pave the way for better products for customers

Retirement Guidance for all – a new national brand is born

No more standard annuities – more individualised, flexible products

by Dr. Ros Altmann

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Millions of pension savers will soon benefit from the pensions flexibilities that will start in April 2015. They will, at last, be trusted with their own money, rather than being forced to choose between expensive and inflexible annuities or income drawdown products that may not suit them. A whole new pension product landscape is opening up.

Following the Chancellor’s Budget bombshell, which heralded the end of draconian restrictions on UK pension funds, the Treasury is today providing more details of how improved choice and flexibility will work. The ambitious programme of National Retirement Guidance is going ahead and opens the door for new and better products, as well as improving financial literacy nation-wide. This is a long-overdue reform which has the potential to improve pension outcomes for tomorrow’s retirees. Indeed, the Guidance could be the start of a whole new industry, which will ensure people have a better idea of how to plan their finances and how to assess their retirement options.

I am pleased that there has been no backtracking on the plans. The popularity of the Chancellor’s decision to allow pension freedom has ensured that the new Guidance will be in place before the next Election and the Treasury is clearly working flat-out to deliver this new programme on time.

These new freedoms should make pensions more popular, ensure more people save for retirement and encourage them to seek expert financial advice to help them decide what is best for them.

Forcing people to buy annuities should have stopped long ago. I believe this will pave the way for a whole range of innovative new products to fit with people’s more flexible, longer lives. Previously, most pension savers who wanted to take money out of their pension fund had no choice but to buy an annuity and pension providers had captive customers coming through their door to purchase these products, so there was little need for innovation and little pressure to offer good value. Annuities have become increasingly expensive as life expectancy has risen and bond yields have fallen.

So what will happen to annuities now?

More individualised annuities, not one-size-fits-all: Many people will probably still buy annuities, but hopefully in future the products they buy will be better tailored to their own circumstances. The Government is going to allow annuity design to be more flexible, so they can fit with people’s increasingly flexible lives. Until now, most just bought the ‘standard’ (single life, level) annuity they were offered at retirement. This took no account of their health or personal circumstances, offered no inflation protection and there were no controls on charges or value for money. In future, the changes announced today can ensure a wider range of annuities and the impartial guidance can help people identify the right type of product and find a good rate.

Annuities bought at older ages: I expect to see a trend towards people only buying annuities much later in life, rather than locking all their savings into an irreversible product that has to last for possibly 20 or 30 years. Age 60 or 65 may be too young to buy annuities, but waiting till later allows time for the annuity to reflect future health or market circumstances.

What new types of annuities might be designed?

Annuities with variable income profile – ‘u’-shaped or ‘j’-shaped to match retirement income needs: At present, annuity income payments are strictly controlled and the rules do not allow the income paid out to fall. However, income needs in retirement are more variable – higher at the start as people spend on their homes, their family, entertainment or travelling – but later on they tend to stay home more and their income needs fall. Right at the end of their life, income needs may rise due to health or care costs, but annuities cannot currently cope with such ‘u’-shaped or even ‘j’-shaped income profiles. It is good that the Government will allow variable annuity income.

Advanced life deferred annuities: The main advantage of buying an annuity is the security of knowing that there will be a secure income stream paid out regularly for life. This is an insurance against living ‘too long’. However, if the annuity has no inflation protection, those who do live for another 25 years or more will find that the real value of their income has been eroded by inflation in later life, while those who do not live a long time will not have received good value. A 65 year old will not need to be protected against reaching 66, but may want protection against living to 96. Buying an annuity that only starts from, say, age 85 or 90, should cost much less than a standard lifetime annuity, since the probability of living to those later ages is lower. Insurance against unlikely events is bound to be cheaper than insuring against events that are almost certain (such as a 65 year old living to 66). In addition, if part of a person’s pension fund has been used to buy an advanced life deferred annuity, which will start paying out in, say, 25 years time, then managing an income drawdown fund becomes much easier and less costly. The problem with income drawdown is that people do not know how long they will need to draw down for. If the period of managing the pension fund is fixed at 25 years, then the income payouts can be safely managed to match that end date. If the person dies before that, the money can pass on to their loved ones, rather than staying with an insurer.

Annuities with a care funding option: Annuities could be designed which offer the option of much higher income, in the event that the person needs later life care. Care funding is a looming crisis and there is no money set aside to pay for social care, either by individuals or by the state. Therefore, the possibility of using people’s pension savings to pay for care could help address one of the biggest social problems of the coming decades. Once an annuity has been purchased, there is no money left to pay for care if it is needed. If the pension fund is retained into later life, the money could be available if required. Ideally, I would like to see the Government incentivise pension fund retention for care by allowing any withdrawals that are used to pay for care to be tax-free. Money taken out is currently taxed, so if someone needed to pay for care with their pension savings, 40% of it could be lost in tax.

Annuities with guarantees: Standard annuities mean pensioners will not benefit from investment market returns during their retirement. Those who live a long time may have closed off their options for investment growth too soon. However, many people are also worried about sharp market falls, so it is possible to buy annuities which protect against big losses, but still offer the chance to gain from higher returns as well. Guaranteed annuities are very popular in the US and Japan and are likely to prove increasingly attractive in the UK.

The table below summarises the changes confirmed today:

Policy	Before Budget	Interim changes up to April 2015	Full flexibility from April 2015
AGE: when you can access your pension fund	Age 55	Age 55	Age 55 – rising to age 57 from 2028
WITHDRAWING SOME MONEY: The rules on taking some money out of your pension fund from age 55	If you took any money at all out of your fund, you had to ‘secure an income’ within 6 months i.e. buy an annuity or drawdown policy, otherwise you faced 55% tax	You only need to ‘secure an income’ within 18 months, so technically don’t need to annuitise (though providers aren’t allowing it!)	No requirement to secure an income i.e. nobody forced to buy an annuity, can choose how much to take each year
CAPPED DRAWDOWN RULES	Annual income taken out of your fund cannot be more than 120% of standard annuity (GAD) rate. Any income above that is taxed at 55%	Annual income withdrawn cannot be more than 150% of standard annuity (GAD) rate. Any income above that is taxed at 55%	No cap on income, all withdrawals taxed at marginal rate. Existing capped drawdown policies protected and if withdrawals don’t exceed 150% of GAD rate, retain full £40,000 Annual Allowance for future contributions
TAX ON DRAWDOWN FUNDS INHERITED:	55% tax deducted from drawdown funds passing on to beneficiaries unless taken as a pension	No interim changes	Tax rate will be lower than 55%. Exact details to be announced in Autumn Statement 2014
CASHING-IN SMALL FUNDS: The rules on cashing in small pension funds as a lump sum from age 55 ( ‘trivial commutation’)	Can only cash in and take small funds as a lump sum if: – your total pensions are worth <£18,000 – or you can cash 2 funds worth up to £2,000.	Can cash in and take small funds as a lump sum if: – your total pension savings are worth <£30,000 – 3 funds up to £10,000 each	Any size pension fund can be taken as cash flexibly, whenever you want after age 55 subject to marginal tax rates
CASHING-IN LARGE FUNDS FLEXIBLY: Rules on cashing-in large pension funds as a lump sum from age 55 (‘flexible drawdown’)	Those with large pension funds can access their money flexibly in flexible drawdown and cash in if they wish as long you already have minimum lifelong pension income of £20,000	You can cash in your fund if: – you already have minimum lifelong pension income of £12,000	Any size pension fund can be taken as cash flexibly, whenever you want after age 55 subject to marginal tax rates
TAX AVOIDANCE PROTECTION: The rules on contributing to future pensions once you have taken as much money as you want from your pension fund	Once you have used flexible drawdown to access your pension savings, no further pension contributions are allowed (£0 annual allowance) – in order to prevent tax avoidance of large ongoing pension contributions	Minimum lifetime pension £12,000pa No further pension contributions (£0 annual allowance)	No minimum pension income required – all drawdown is flexible. Allow extra pension contributions – £10,000 annual allowance [BUT can retain full Annual Allowance if cash in 3 pots up to £10,000 each or unlimited small occupational pots]
ANNUITY DESIGN: The rules for annuities – what limits on product design?	Inflexible. Income must remain same or increase every year, never fall. Maximum 10-year guarantee for ongoing income after death. Money-back guarantee (value protection) is available but funds inherited on death are taxed at 55%. Can’t take lump sums if need to pay for care.	No interim changes	Will allow variable income stream. Will allow lump sum payments up to £30,000 (if specified at time of purchase). 10-year maximum guarantee removed, unlimited guarantees to allow more fund to pass on at death. Funds up to £30,000 can be paid as lump sum rather than ongoing income
ANNUITY SALES: Rules governing sale of annuities and information given to customers before pension fund converted to income	No requirement for suitability checks before annuity sales. No control on value for money or commission deducted at sale. Pension providers must send information on pension fund (‘wake up pack’) around 4-6 months before pension age and again 6 weeks before and must offer an annuity. Must inform of ‘open market option’ but no requirement to check suitability or warn of risks.	Still no requirements for suitability checks, providers must inform of open market option	Providers will have to provide standard information for customers to use in Guidance session. Will have to inform customers of how to access the free Guidance – this applies to each pension pot. May lead to ‘Pensions I.D.’ card or ‘Passport’ and eventually hope to have commonality for multiple funds all in same format
GUIDANCE AT RETIREMENT:	No actual personalised guidance offered at retirement. No personal information taken into account when communicating with customers other than age and pension fund size. Relevant questions on health, other options not asked	Still no guidance	Guidance Guarantee starts April 2015. Free, impartial, tailored guidance to go through options, warn of tax implications, signpost to more information or professional advice. Guides must not have connection with products or providers. Will not be FCA regulated but will be authorised and approved by Treasury. Funded by levy on all financial providers
TRANSFERRING DC PENSION FUNDS:	You have the right to transfer to another provider up to one year before pension age	No interim changes	You can transfer at any time, including at pension age if desired (to ensure everyone can take advantage of flexible access)
DB TO DC TRANSFERS: Transfer from DB (final salary-type) schemes to DC schemes	Transfers permitted for non-pensioner members. Taking advice before transfer is only an actual requirement if transfer instigated by the employer. Trustees have power to delay timing of transfer and to reduce value to reflect scheme under-funding but many may not be fully aware of this power	No interim change	All funded DB scheme non-pensioner members will be allowed to transfer to DC. Safeguards strengthened so every member must have independent advice from an FCA-regulated adviser before transfer a pension worth over £30,000. Guidance for trustees strengthened to ensure they know they can delay timing and reduce transfer values to reflect scheme funding level. Unfunded public sector schemes (e.g. NHS, teachers, civil servants) will not allow transfers except in exceptional circumstances but funded public schemes (i.e. local authorities and MPs)will allow transfers
FUNDING SOCIAL CARE:	No incentives to save for social care. Capital in pension funds or drawdown ignored for purposes of means-test, use a notional income, but no encouragement to set aside pensions or other savings for care	No interim change	No new incentives to save for social care, however money that remains in pension fund without being annuitized could be used if required. The Guidance must explain issues of social care funding to increase awareness and discourage withdrawals

The Guidance Guarantee – a whole new industry of impartial guides?

The Treasury has released more details of its plans to ensure everyone with DC pension savings is offered free, impartial financial guidance on their pension options to ensure they are better informed and educated on their retirement finance options. This is a real game-changer and could be the start of a whole new industry. It will be entirely separate from any provider of at retirement financial products or services and focussed on financial education and financial planning and aims to help people consider the important questions they need to ask before making decisions at retirement – something that should have been in place long ago. However, it will not provide the answers – customers will be left to make their own decisions – so many may need expert independent financial advice to help them.

Will the Guides be regulated by the FCA? Guidance is not the same as regulated advice. The Guides will not be authorised by the FCA but the Regulator will oversee the standards. For the initial phase, the Treasury will control the approval and authorisation of firms or organisations to carry out the work.

New National Retirement Guidance Service: The intention is to build up a new, national brand of ‘Retirement Pension Guides’ who consumers will trust and be happy to go to before making retirement decisions. This could mark the beginning of a new industry. These officially approved guides will need to operate to consistent, robust, well-enforced standards. An expert team at the Treasury will work with TPAS (The Pensions Advisory Service) and MAS (Money Advice Service) and an advisory board of experts to decide how best to provide the information and guidance.

How will the guidance sessions work? The outline suggests a centrally-run telephone and on-line service which all those reaching scheme pension age will be signposted to. Individuals will call or register on line and can choose whether they want to just use web-based, telephone-based or face-to-face sessions. Many will not want to actually meet a Guide in person, so offering a range of different channels is sensible.

What will the guidance cover? The guidance will be tailored to the individual’s specific circumstances and will cover their options at retirement. It should explain the tax implications of any choices they may make, take account of their other income and dependants’ needs. Pension providers will have to give all customers standardised information about their pension savings – any guarantees, the value of the funds and any special features.

What will the guidance not cover? The guidance will not tell anyone what products to buy, which providers to use or which adviser to go to. For individual product recommendations, people will be told they may need to consult an independent financial adviser.

Who will pay for it? It will be free to the customer and paid for by a levy on financial firms.

Who will be eligible for the free sessions? Guidance is available for each pension pot, so people with more than one pension fund will be entitled to more than one guidance session.

So what happens next?

We will have two new Pensions Bills in the Autumn. A Pension Schemes Bill, which will deal with the Guidance Guarantee, public sector pension transfers and pension flexibility (this Bill is already going through Parliament with the DWP’s proposals for ‘Defined Ambition’ pensions). A Pension Tax Bill that will remove the restrictions on DC pensions, increase the flexibility of income drawdown and introduce measures to prevent tax avoidance for those who take money out of their pension funds and keep reinvesting in pensions to receive more tax relief. This Bill will be presented in August 2014. The FCA will meanwhile be consulting on how the Guidance Guarantee should work and the Treasury will be working to finalise the introduction of the Guidance in time to start in April 2015.