It’s a decade since the government announced the end of compulsory annuitisation. What effect has it had?

“Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits.

“Let me be clear. No one will have to buy an annuity.”

This week – specifically, 19 March – marks a decade since the then-chancellor George Osborne said the above in his 2014 Budget speech, signalling one of the biggest changes to the retirement industry in recent history.

At a stroke, Osborne had completely changed the at-retirement landscape and forced providers to rethink their default investment strategies, most of which were geared towards preparing savers for an annuity purchase.

Osborne and pensions minister Steve Webb tried to go even further 12 months later with the suggestion of a secondary market for annuities, but this didn’t get off the ground.

At the time, Pensions Expert reported industry fears that default funds were no longer fit for purpose, with lifestyle strategies having to be completely overhauled. Some predicted a collapse in annuity sales, while others warned of pensioner poverty through retirees overspending.

A decade on from the announcement, how has the pension freedoms policy changed the industry? And are members really better off?

Annuities post-freedoms
There was a drop-off in annuity sales immediately following the introduction of the freedoms, but this may be as much to do with the ultra-low interest rate environment of the time.

Indeed, annuity sales have steadily increased over the past few quarters as interest rates have risen. Data from the Association of British Insurers (ABI) published in February showed that annuity sales totalled £5.2bn in 2023, up by 46% on the previous year and boosted by £1.5bn of sales in the fourth quarter of the year. This was the highest annual total since Osborne’s pension freedoms announcement.

The ABI also found that more than 72,000 annuity contracts were sold during 2023, the highest number since 2016, which the association said reflected “strong consumer desire to lock in a guaranteed income for their later years”.

However, other data indicates that drawdown is the preferred option for many more savers. Since April 2015, HM Revenue and Customs (HMRC) figures show that more than £72bn has been accessed through the new flexibilities. The Financial Conduct Authority says more than 205,000 people accessed their pension pots through drawdown policies for the first time in the 2021-22 financial year.

The tax issue
One of the biggest problems faced by people accessing their pensions through drawdown is HMRC’s long-running overtaxing issue.

The tax authority typically estimates a drawdown customer’s tax by dividing their tax allowance by 12 and applying that to the amount withdrawn in the first month, which AJ Bell’s director of public policy Tom Selby says can result in “shock tax bills often running into thousands of pounds”.

This can particularly affect people making one-off, rather than regular, withdrawals.

AJ Bell estimates that almost £1.2bn has been overtaxed this way. While savers can get tax refunds, it requires them to quickly spot the issue and fill out the correct form – or else wait until the end of the tax year for HMRC to correct the error.

“It is high time these systems were upgraded so people who use the freedoms as intended aren’t forced to go crawling to [HMRC] to get their money,” Selby says.

Access to advice
In his Budget speech in 2014, George Osborne pledged to ensure all DC retirees received “free, impartial, face-to-face advice” to help them understand their options.

However, delivering this has been difficult. The government’s Money and Pensions Service is now responsible for Pension Wise, which offers free guidance to people reaching retirement, but FCA data shows that only a third of those accessing a DC pot in the past four years used the service.

Research by Standard Life indicates that many people are uncertain about their options or do not feel confident in their ability to manage their pension themselves.

Among people aged over 55 who have heard of pension freedoms, Standard Life found that 24% felt “unsure about whether they know and understand the different options and rules around accessing their pension funds”, while 13% were not confident about this.

In addition, 15% of those aged over 55 said they felt overwhelmed by their at-retirement options and 16% said they didn’t understand rules around accessing their pensions. Another 7% have put off withdrawing money from their pension because they don’t understand their options.

Mike Ambery, retirement savings director at Standard Life, says more needed to be done to ensure people feel confident around retirement decisions.

“As things stand, many also reach retirement with less in their pension than they’d expected, making the decision on how to access limited savings even more vital, and difficult,” he says.

The FCA is currently consulting on changes around the definitions of financial advice – which is regulated – and guidance, to make it easier for more people to get the information they need. “Improving access to affordable financial advice is key to improving people’s confidence and chance of securing good retirement outcomes,” Ambery added.

The ramifications
One of the biggest knock-on impacts of the pension freedoms policy was on defined benefit (DB) transfers. The government made it easier for those with small DB pots to transfer to DC arrangements with more flexibility.

However, the British Steel Pension Scheme scandal cast a light on questionable practices by some financial advice companies facilitating DB transfers. Many steelworkers were given inappropriate advice to transfer out of their DB scheme into personal pension arrangements, often with investment portfolios charging high fees.

This led the FCA, at the behest of the Work and Pensions Committee, to carry out a full review of DB transfers. It found that more than two thirds of DB scheme members who sought advice between April 2015 and September 2018 were recommended to transfer. In addition, six in 10 firms reviewed by the FCA recommended a transfer to at least three quarters of clients – figures the regulator labelled “concerning”.

Several individuals and firms have been fined, banned from providing DB transfer advice, or even booted out of the financial services industry altogether following the FCA’s actions. The regulator has since raised the bar significantly for DB transfers and remains of the view that, in most cases, transferring out of a DB scheme is “unlikely to be suitable”.

The future
As the transition from defined benefit savings to DC continues to gather pace, the latter will increasingly become the main source of retirement income.

As Kathryn Fleming, head of DC at-retirement services at Hymans Robertson, says, this means pension freedoms “could be a powerful tool allowing members to personalise and maximise their retirement incomes, by being able to flex and intertwine them with other savings and assets”.

However, she warns that this “will only be feasible if they are accessed with appropriate support”.

David Sinclair, chief executive of the International Longevity Centre, says: “Looking ahead, the retirement prospects for future generations appear grim… Politicians are reluctant to tackle the tough decisions necessary to address these looming challenges. Even discussions around increasing the state pension age are met with avoidance.”

He cited low contribution rates and the increasing prevalence of renting over homeownership as significant factors in the “bleak picture” of future retirement.

“Government intervention needs to be bold and quick,” Sinclair said. “Measures such as automatic pension contribution escalation, the introduction of sidecar savings, and auto-enrolment for the self-employed are crucial steps.”

He suggested the use of artificial intelligence and similar technologies to improve access to financial advice as well as guidance. In addition, Sinclair said it was “essential” that the financial services industry invest in products tailored to the needs of gig economy workers.

“Action must be swift, not bogged down by years of fruitless debate and consultations,” he said. “The next government must not shy away from the need to be bold.”


More Related Articles...

Published: March 22, 2024
Home » Pension freedoms 10 years on: A progress report

More Related Articles...