BLOG: Consumer risk in the era of pensions freedom

Written by: Duncan Robertson
After decades of living under a rigid system of retirement planning, consumers are now confronted by a rich array of options. But without sufficient education about the attendant risks, are consumers truly in the best position to take crucial decisions about their future?

With the arrival of April’s pension reforms, the industry has been watching and weighing up the consequences for consumers and providers. Six months on, the upheaval has certainly produced a complex picture – one which can easily confuse consumers. Indeed since the announcement of the reforms the annuities market has experienced fluctuating interest levels, being viewed by a mixture of confusion, trepidation and boldness on the part of consumers.

So, bearing in mind annuities’ retreat in an era where choice is now king, in what ways are consumers approaching retirement taking advantage of the new freedoms? Are they truly in a position to weigh up the options available to them? From a risk standpoint, are too many people unaware of what’s involved in choosing a traditional drawdown product?

According to recent figures compiled by the Association of British Insurers (ABI), almost 65,000 cash withdrawals took place between April and July 2015. By way of added background to these statistics, this amounts to £1bn worth of cash lump sums. The high volume of these cash withdrawals, occurring as they have under the terms of the Uncrystallised Funds Pension Lump Sum (UFPLS) arrangement, should raise some serious questions about whether the industry’s customers are aware of the risks attached to a ‘cash-only’ approach to retirement. This is an unprecedented number, and takes the Government, industry and consumers into uncharted territory.

Annuities have of course experienced knock-on consequences as a result of this trend. Despite an earlier downturn in their fortunes, rising demand for annuities (as consumers shop around for their ideal product) has occurred at an increased rate. While £1.2bn was invested in annuity products during April and May 2012, this year just £630m was used to purchase annuities during the same two-month period.

However, demand increased by 32 per cent between April and June 2015, demonstrating annuities are once again front of mind for consumers. Whatever consumers’ choices, these figures suggest consumers are cashing out at a time when many lack the background knowledge allowing individuals to take informed decisions about their retirement.

In time, many of those making these withdrawals and investments will in all likelihood turn out to be from hesitant investors, who have opted to take their pots as a lump sum while they weigh up which retirement option suits them best. Does this raise the possibility too many people will start to believe the ‘cash-only approach’ is the silver bullet to their retirement needs?

Take this as an example. On the basis of an average cash deposit of £100,000, a 65 year old taking the cash-funded option and relying on this for income (in this case £4,250 p.a.) will have run out of half their money by age 78 and there’s a one in three  chance all of their money will be gone by age 90.

But it’s not just those weighing up the cash options open to them who may be at risk. Those who take an alternative course of action need to acquaint themselves with the pitfalls which often underpin some of the more traditional options. Although the exact structure of these products varies, given their reliance on market activity the downside potential for consumers is significant.

Put simply, consumers attracted to the prospect of substantial returns may be caught off guard by the adverse (and unintended) consequences of a decline in market performance. According to other figures compiled by the ABI, the average fund put into drawdown between April and May was £69,900, indicating those with more modest pension funds believe they can increase the value of their fund by capitalising on the often erratic, but occasionally high-yield drawdown route. Savers invested a total of £720m to buy a total of 10,300 income drawdown policies.

All in all, these are substantial sums, and given their scale it is essential the industry does its utmost to assist consumers in adjusting to the pace of industry upheaval.

In line with these figures, I believe the industry needs to encourage consumers to adopt a longer-term perspective to their retirement needs. Predictions by consumers on how long their retirement may last are frequently underestimated, and this reliance on speculation rather than long-term financial prudence could create a situation where individuals are susceptible to a shortfall in funds during the most vulnerable time in their lives.

With this in mind, it is key for consumers to become informed/empowered enough to think more broadly about how choosing a more stable form of long-term retirement income is in their interests. Whatever option is most suitable for them, ultimately there needs to be a broader level of awareness on the part of retirees to ensure the promising summer of freedom doesn’t turn into a gloomy winter of pension discontent.

Duncan Robertson is marketing director of Aegon Ireland.

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