BLOG: Pensions – New freedom, new responsibility
Further details have emerged of the brave new world for retirees that will begin next April. The Government’s draft legislation on pension reform – first announced in March’s budget – answers some key questions and confirms the thrust of a radical change to the way we will provide for our lives after work.
The first announcement foucsed on the guidance which the Government promised in March as a way of ensuring that the new liberalised regime does not simply result in people making imprudent decisions that lead to them running out of cash and falling back on the state.
The Government has confirmed that guidance will be free and independent of pension providers. Instead the industry will pay a levy so that the Government can help retirees via its Pensions Advisory Service and the Money Advice Service.
The second key announcement means the new freedoms will be extended to the beneficiaries of defined benefit (final salary) pensions as well as those in defined contribution (money purchase) schemes.
People will continue to be able to transfer out of defined benefit schemes and into DC equivalents in order to take advantage of the new freedom to access their full pension pots at retirement (subject to marginal income tax rates) or invest them in an income drawdown arrangement.
There are a couple of caveats to help prevent people making an expensive mistake here, the more important of which is that anyone contemplating a move from DB to DC must take independent financial advice before doing so.
There are many advantages to defined benefit pensions – often including inflation-proofing and spouse’s income – and no-one should give up on these without a very clear understanding of the risks and potential benefits.
In principal, the new freedoms are undoubtedly a good thing. They recognise that well-informed, advised or guided, individuals are the best judge of how to use their hard-earned retirement savings – not a bureaucrat in Whitehall.
Anything which reins in the Nanny state and treats people as adults is probably a good thing. The unintended consequence of restricting people’s freedom to use their pension pots as they choose was that many people just didn’t bother to save at all.
Nobody has any excuse now not to engage with their retirement.
One of the principal criticisms of the decision to allow people to escape the straitjacket of compulsory annuitisation is that they will take full advantage of their new freedom and blow their savings. The Chancellor’s view is that this is patronising and that most people are sensible enough to do the right thing with their savings. I think he is probably right.
In fact, I think the greater danger is not that people are too reckless with their savings but that they are too cautious. Loss aversion means many people will shelter in the perceived safety of cash in retirement and lose their money slowly, via inflation, rather than quickly as a result of poor investments or the purchase of Lamborghinis.
The big challenge for people now will be using their new freedom sensibly.
Making decisions about a retirement which might last for 30 or more years is no simple matter, especially when it hinges on a rational judgement about a subject none of us really likes to think about – our unavoidable mortality.
The Government is right to ensure that everyone receives some help at retirement. But ultimately the responsibility lies with all of us to develop an interest in our personal finances.
Pensions may be boring, but how interesting do you think old age poverty might be?
Tom Stevenson is investment director at Fidelity Personal Investing.