My Lords, from April 2015, when people reach the age of 55, they will be able to access their defined contribution pension savings as they wish. That will essentially leave them with four choices: full withdrawal of cash, taxed at their marginal rate, less a 25% tax-free lump sum; some kind of income draw-down product, drawing down cash while leaving the remainder invested; taking uncrystallised funds pension lump sums; an annuity purchase; or any combination of the four.
We do not know how the market will evolve in light of the new unprecedented options for pension savers in terms of the retirement products that will be available and what their charges will be. However, we do know that the FCA thinks, first, that the new freedoms could weaken the competitive pressure on providers to offer good value, because people display even more inertia in the face of complexity; and, secondly, that providers have been struggling to complete proper due diligence testing on new products because of the tight timetable. We do not have clarity as to the Government’s thinking on the charges, quality standards and transparency requirements for retirement income products going forward.
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There is a significant risk that some individuals will be overtaxed because, in the face of complexity, people will get security from putting their savings in the bank. As the Strategic Society Centre suggests, instead of trying to understand the complexities of various retirement income products, people may choose to put their money into easy-access savings accounts which do not commit them to any course of action. Individuals can take 20% of their DC pot as tax-free cash and the rest at the marginal rate of tax, but an International Longevity Centre survey suggests that people do not understand the term “marginal tax rate”, and that this could result in them facing a significant tax bill, generating less income for their retirement. This may boost government tax revenues but it will also result in individuals having less to live on in their retirement. I fear that those with modest savings pots will be more vulnerable to being overtaxed than the confident, wealthier saver who can afford ongoing advice—a fear shared in a recent report by the Pensions Policy Institute and, indeed, by the FCA.
An article in today’s FT refers to Channel 4’s “Dispatches” programme and to research by industry analysts that estimates that about £6 billion of cash—three times the government estimate of £2 billion—will be taken out of pension pots following the introduction
of the new freedoms. The CEO of the FCA, Martin Wheatley, said in an article last weekend:
“The beauty of an annuity is at least you make a decision. Faced with complexity … we prevaricate or put it off. And then we rely on very simple stimulus, so if someone says you can have £1,000 in the bank tomorrow if you make a decision, people are going to make snap judgements”.
He added:
“The worry is not those with the largest pots, but those with a £20,000 pot when the cost of providing advice may be excessive relative to the pot size”.
In the face of that risk, the availability of well regulated, low-cost, low-risk ways of accessing pension savings efficiently on an income draw-down basis or through uncrystallised funds pension lump sums and reforms to the annuity market become even more important, particularly for lower and moderate earners.
The Government have set a 0.75% charge cap for auto-enrolment default investment funds but there is no cap for retirement income products. The cost of income draw-down and the charges will come under intense scrutiny and fierce debate. The FCA market review has revealed that charges in these products can be high. Yet retail income draw-down products will not be scrutinised by the independent governance committees that have been put in place within the pensions industry. These products are not risk-free; savings remain invested. As these products become more of a mass market, I expect future savers to react to investment falls, charges and spending cash far too quickly.
The FCA’s head of investment, David Geale, speaking to the Public Bill Committee, has already highlighted the risk of draw-down under the present range of products for those with pension pots worth less than £50,000. He added that,
“there is no reason why over time flexible access products need to be poor value for money or to represent a high element of risk”.
But he acknowledged that,
“we will see how the market develops”.—[Official Report, Commons, Taxation of Pensions Bill Committee, 11/11/14; col. 10.]
If the evolving market starts to offer non-advised income draw-down products, particularly for those with smaller pots, the need for controls over charges becomes even greater. A key emerging issue is whether after April 2015 there will be income draw-down products suitable for modest-income pension savers. Because of the potential risks and costs to the consumer, the Government should take the initiative by embracing a power within the Bill to impose a cap on the fees and charges in a core of flexi-access draw-down products that could be readily available to ordinary pension savers.
Uncrystallised funds pension lump sums—a catchy little title for a measure that will allow people to keep drawing lump sums from uncrystallised pension funds, with 25% of each sum tax-free and the remainder being taxed at their marginal rate, without having to crystallise the whole pension pot—are intended to form the basis of the Government’s pension bank account concept. It is a good concept but who will provide them? Employers may be reluctant to provide the facility through their company schemes. On the contrary, they seem increasingly inclined to ask ex-employees and pensioners to move their savings out of the company
scheme. Therefore, it is likely to be industry providers that provide such a product. But what will their fees be for looking after people’s money and what will they charge every time someone takes money out of their pot? The amendment allows the Government to take the initiative to set a cap on the fees and charges that can be imposed by those providing access to uncrystallised funds pension lump sums—it is quite hard to say—so preventing poor value.
The pension freedoms in the 2014 Budget still require a properly functioning annuities market and we will inevitably return, I believe, to a political recognition that it is in the national interest to have one. The ILC report has a section headed:
“The catastrophic costs of taking money out of the pension and putting it into a savings account”,
which concludes that if individuals tried to use their ISA to give them a comparable retirement income to an annuity, many would run out of money long before they died. Will the market promote a more flexible portfolio of annuities, such as deferred or fixed-term annuities? A lack of annuity contract standardisation has rendered price comparison websites ineffective and unfair sales practices have deprived pensioners of significant income. The open market option has not worked—perhaps it is time to look at more radical options.
There is not time to meet all the challenges associated with the new freedoms in pensions before April 2015—this is work in progress for some time to come. But it is the right time to recognise that the Government should be given the powers to regulate and control the charges and the quality standards of these products. The pension freedoms announced in the Budget trust savers to make the right choices, but those right choices will not occur solely as a function of trust in the consumer; they require good behaviour by the providers. The Government have enshrined in statute the power to set quality standards and control charges in the market during the accumulation stage. This amendment would give the Government the ability to exercise such controls also on retirement products during the decumulation phase.