Pensions in a muddle

01 March 2019

This article was featured in the March 2019 issue of the magazine.

Henry Tapper, director of First Actuarial, discusses moves to protect pensions of those retiring

Five years after pension freedoms were announced in the 2014 budget, and introduced by Finance Act 2015, the Financial Conduct Authority (FCA) is hoping to put in place a new set of rules to protect the million or so people who retire each year. Though the original plan was for financial empowerment, increasingly regulators are talking of financial vulnerability. 

According to recent FCA research, 94% of us are not taking financial advice; and even at the most crucial juncture, when we stop saving and start spending our retirement pot, two thirds of us are doing so without any professional help.

Pensions Wise, the government’s appointed agency for giving help to people when they retire, gets a 10% take-up, which means 90% of those eligible for a free review of their at-retirement finances aren’t taking up the offer. The government hopes this percentage goes up with the establishment of its new Single Financial Guidance Body, but to most people, little has changed.

The FCA’s new rules are expected to usher in three new ideas:

Default investment pathways, established by companies providing people with income drawdown, will act as default investment strategies depending on financial goals.

An obligation on income drawdown providers to ensure people are invested in cash out of choice rather than because they haven’t taken any other decision.

Disclosure of what they are paying for – their pensions in pounds and pence.

There are many inside and outside government calling for much more. Both the Department for Work and Pensions and Which? have called for the charge cap on workplace pensions to be extended ‘to and through” drawdown. This could substantially reduce the cost of the drawdown policy but might also drive away advisers who might not want to operate under constrained margins.

This brings into sharp focus the question ‘can ordinary people afford to manage their retirement income under the pension freedoms?’ Increasingly people are looking back to the pre-2014 paradigm where the default position was that people exchanged their accumulated retirement savings for an annuity. 

In the most recent quarterly figures produced by HM Revenue & Customs, the amount actually drawn down through personal pensions reached a record £7bn in the last quarter of 2019. But this figure does not even match the transfer of cash from defined benefit (DB) to defined contribution (DC) schemes; and it’s tiny compared with the amounts paid out through DB workplace pensions and even tinier when compared with what’s paid out by the state.


...the social advantages are lost if people do not convert savings into a lifetime income


Anecdotal reports from pension providers that offer drawdown is that the majority of policyholders who start or ‘crystallise’ drawdown, are only taking tax-free cash and leaving the taxable income in the pots. This would certainly make sense of the low level of drawdown.

From research that my company has carried out, people who do not get advice are tending to do nothing about setting up a retirement income stream. This may not be as surprising as it seems; an eminent financial economist, William Sharpe, has called the business of converting a cash sum to an income for the rest of your life “one of the nastiest hardest problems in finance”.

This should matter to pension and payroll people. The point of pensions is to help people to move seamlessly from work to retirement when they reach the end of their working lives. Pensions are generally considered a replacement wage in retirement but if they have morphed into money that rolls up into an inheritance or is blown on fast living, we are likely to see both social and business problems.

The point of tax advantages given to pensions is that pensions provide an insurance against old-age. But the social advantages are lost if people do not convert savings into a lifetime income.

Similarly, the traditional reasons for running a pension within the workplace are not being satisfied. Unless savings are converted to income, then people will find it harder to stop work and the workplace becomes top-heavy with baby boomers not wanting to move on.

It is in answer to the societal and commercial reasons for pensions, that companies are beginning to question whether all this freedom is such a good idea after all. Royal Mail’s request to start a collective DC scheme, could be seen as a response to the failures of retirement savings plans rather than an answer to the problems created by its old DB plan.

In the light of the radical solution that Royal Mail has come up with, many will feel that the FCA are tinkering around the edges of the problem. It will be interesting to see whether drawdown can reinvent itself and become the mass-market alternative to annuities, whether we move to a system of non-guaranteed CDC pensions or continue with the current muddle.