Pensions – Don’t Spend It All At Once

by | Apr 7, 2014

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George Osborne has opened up a chest of wonders, our writers report. But does anyone understand what it all means?

 

Okay, we’ll admit to being a bit surprised ourselves, here at IFA Magazine. Little did we think, when the Chancellor stood up to deliver the Budget speech on 19th March, that by the time he sat down again he’d have done away with the best part of a century of pensions practice in the UK, and liberated a generation of soon-to-be pensioners from the infernal shackles of an annuity system that really hasn’t made sense for half a decade now.

Yes, from April 2015 the estimated 400,000 people who retire each year will be able to take all the savings built up in a defined contribution pension as a cash lump sum, at their marginal rate of tax beyond the first 25%. And the mandatory perils of an annuity – the erosion from inflation, the total loss upon an early death, and the simple fact of having shaken hands on a binding lifetime commitment – are no more.

The Devil’s In the Details

Nearly a month has now passed since the glad tidings hit the airwaves, and we’re still taking in the shock of it. For most, the joy is undiminished. For some, however, the longer-term implications are sinking in only rather painfully. And the adviser forums at LinkedIn and Life Talk have been buzzing with animated and sometimes fanciful discussion about what lies ahead.

First impressions are that the Chancellor appears to have taken the plunge without thinking very hard about exactly how the new proposals will impact on the industry, and on the major financial players in particular. That includes the Treasury itself, which is going to be shelling out a lot of money in ten years’ time.

But it’ll be another twelve months before the new proposals kick in. And another two months, maybe three, before the Finance Bill that will bring it all to life can get through the committee stage and be passed into law. That’s a year in which any necessary catch-clauses can be inserted. But here’s our blue-sky thinking, for better or worse.

thumbs up smallthumbs up smallRejoice: It’ll mean far more business for advisers

There is no way, unless the Chancellor changes his mind, that this can mean anything but a useful boost for advisers, and especially those who have been building up their holistic relationships with their clients. If the popular prediction of a 90% fall in annuity purchases is correct – and even Barclays is talking about 70% – that would imply that between £8 billion and £11 billion of new drawdowns will be happening every year.

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Objection: It’ll bankrupt the life insurers

It seems pretty clear that the last month’s massive share price plunges at Prudential, Axa Life, L&G and Resolution reflect a serious and lasting burden that the Chancellor has laid on their shoulders. The fact that a group of them are considering a legal challenge against the Treasury for kaiboshing their businesses – or at least, for not warning them in advance of the impending catastrophe – is also significant.

RBC Capital Markets reckoned last month that only 10% of customers will now be likely to buy an annuity; another 10% will choose income drawdown, while the remaining 80% will take simply take cash.”

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Rejoice: It’s great news for asset managers

Asset managers, wealth managers and DFMs have been presented with a gift that they could scarcely have expected just a few months ago. Bank of America/Merrill Lynch were first off the blocks with a view that Henderson, Jupiter and Schroders would be in a position to win by providing “less volatile versions of the “multi-asset or balanced funds, or possibly some kind of hedge fund product” that might rival annuities. And at Fidelity they were talking about flexible annuities that could be topped up every year, or perhaps multi-asset income funds that would aim to limit capital losses.

Frankly, nobody knows what forms the new funds will take. But with maybe £8 billion a year of new business in the pot, we can expect some imaginative solutions.

thumbs down smallObjection: It’s unfair on last year’s pensioners

Yes, indeed it is. Anyone who bought an annuity before this April will be quietly – or perhaps noisily – cursing his (or her) fate for having been among the unwitting suckers who fell for the old line about how annuities were the only way forward, and that they would ever remain so.

We haven’t yet seen how this disgruntled rump will organise itself, or what arguments it will advance in favour of recompense. All we know is that some advisers’ telephones will be ringing red hot with furious clients demanding to know why they weren’t advised in advance that this might be in the offing. Advisers will be clearly able to demonstrate that they had no prior knowledge. But a million angry clients are a million angry clients.

As for those who’ll be retiring between now and next April, the Treasury is making its own transitional arrangements. But you could hardly be surprised if an awful lot of people decide to stay in employment for an extra year to see how it all pans out.

thumbs up smallRejoice: It will mean more scope for unregulated investments

Unless we’ve got our calculations very wrong, we’re likely to see a big expansion of the numbers of ‘sophisticated’ or high net worth investors out there. At present, the FCA’s HNW definition extends to individuals with incomes of £100,000 a year or investable capital of £250,000. But, for entirely practical and understandable reasons, most have been reluctant to include locked-up pension pots within that figure. So if middle-ranking over-55s with pension pots of, say, £200,000 should now decide to take even half of that money as cash drawdowns, it will be enough to tip quite a few of them into what the regulator would certainly have to concede was affluence.

This is timely, because the cutbacks on lifetime pension contributions from 6th April probably mean that clients earning as little as £50,000 will need at some point to consider alternative investments. We have yet to see how this all will pan out in legal terms.

thumbs down smallObjection: Half of them will only blow it all on fast cars

There is, of course, a definite risk here to the Treasury – namely, that the nation’s wrinklies will treat themselves to one last blast down memory lane with a brand new Porsche that they may – or may not! – have the skills and the reaction times to keep under control on the road. Or embark on a motorcycle tour of Europe.

For what it’s worth, my guess is that only a small minority of pensioners would ever be so reckless. Fast cars cost a fortune to run and insure, and motorbikes are a famously short-term life choice for the Easy Rider generation, who are most;y more sensible than that.

It’s very likely, though, that a great many retired people will grab the opportunity to cruise the world in a comfort that they never managed to enjoy while still in the workforce. And that many more baby boomers will gift substantial sums to their grandchildren, to help them get a foot on the property ladder which they themselves are often blamed for snatching away from the young ones.

thumbs down smallObjection: It’ll drive down the annuity rate even further

This one takes a bit more working out. As far as we can tell at present, the people most likely to switch out of annuities will be the higher earners with more sophisticated approaches to personal finance – and the ones who are most likely to stay in will be the lower to middle earners with smaller pots of up to £50,000 – exactly the people who the annuity providers already find it hard to make money out of. The most likely outcome is that annuities will be forced down still further.

thumbs up smallRejoice: The cross-selling opportunities are excellent

Again, this isn’t so obvious until you look at it carefully. A generation of older people who have more control over their finances are more likely to consider luxuries like private health insurance, long term care options and other things that they wouldn’t have thought were within their budgets until now.

thumbs down smallObjection: “They’ll only spend it and then plead poverty”

This is a real political possibility, and one that the Chancellor needs to consider carefully. How, exactly, does he propose to protect the Treasury from a tidal wave of applications for means-tested benefits from those who have reduced their savings to less than the qualifying thresholds?

"Annuities have become so unpopular in recent years that full commutation may become the default crystallisation option for DC scheme members,” said Pensions Management Institute chief executive Vince Linnane recently. “Whilst the Treasury may benefit from increased tax revenues over the short term, there is a risk that many retirees will run out of funds prematurely and place new demands on the social security system. …There could be a significant number of retirees with no pension income other than that provided by the State – the very problem that automatic enrolment was designed to address."

Surely, you might object, no sane person would deliberately throw himself upon the mercy of the state by jettisoning his financial parachute? And yet, human nature being what it is, it seems certain that many thousands of people in borderline situations will try.

thumbs up smallRejoice: It may boost the housing market and provide flexibility

Millions of pensioners who’ll be getting a big cash boost may decide to plough it into property. That wouldn’t be good for soaring prices at the higher end of the scale, but it will help their grandchildren if, as many expect, the Bank of Grandpa and Grandma can be engaged to help younger generations get onto the housing ladder.

Expect, also, that some of the liberated money will find its way trickling down to grandchildren in other ways. University fees, help with young family finances and holiday spending will all play a part.

thumbs down smallObjection: It’ll make a lot of cowboys very rich

Alas, it seems almost inevitable that a generation of unsophisticated investors will be vulnerable to attack by predatory operators who are interested only in the soft underbelly. Whether it’s high-risk, high-return funds or property pyramids or non-qualifying EIS schemes or flat-out illegal systems such as boiler rooms and Ponzi scams, the certainty is that people will fall for these things.

For advisers, the important thing will be to maintain meticulous notes of any conversations with clients, so as to head off any subsequent accusations that they were somehow negligent in ‘giving the nod’ to investments that were fated from the start to go wrong.

thumbs up smallRejoice: It’ll be a great opportunity for those advisers who have invested in their images

No further comment seems necessary, really. Does it, now?

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