Like sinister Siamese twins, the words ‘pension’ and ‘scandal’ seem to have become joined at the hip. So perhaps it is no surprise that some very good news — perhaps the coalition’s most important extension of choice during its first year — was largely ignored by the media last month.
Most people these days are deeply suspicious of all forms of pension scheme — and rightly so. Traditional insurance company funds have a reputation for high costs and low returns, with far too much of savers’ money sticking to the salesman’s shovel. Company schemes are being slashed as firms concentrate on surviving rather than worrying about their former employees’ old age.
At the same time, the great Ponzi schemes of unfunded state and public-sector pensions are unravelling, as politicians seek to reduce the cost to taxpayers by raising retirement ages and changing the way indexation is calculated. Breaking links with the Retail Prices Index and switching instead to the consistently lower Consumer Prices Index may sound like a technicality, but this will reduce benefits paid to pensioners by billions of pounds in the years ahead.
No wonder editors think all news about pensions is most likely to be bad news, and cynicism abounds. Unfortunately, while any fool can opt out of saving, it is much more difficult to opt out of growing old. So it is just as well that — despite fierce opposition from HM Revenue & Customs — the government has dismantled one of the main barriers deterring people from funding their retirement properly.
Savers can now enjoy much greater choice about how they spend their pension funds since the old requirement to use at least three quarters of the money to buy a guaranteed income for life — compulsory annuitisation — was scrapped last month. Annuities have always been unpopular because they entail irrevocably transferring your capital to a life company and hoping you live long enough to get it back in income payments. Instead, silver savers now have the freedom to retain control of their capital, leaving their funds invested and living off income generated by the underlying assets.
You can see why the Revenue hates the idea. It has long regarded pensions as a form of tax avoidance — which indeed they are — and there continue to be a plethora of restrictions to prevent ‘tax leakage’ turning into a deluge. For example, where a pensioner opts to draw income rather than buy an annuity and then dies before all the assets have been exhausted, there will be a 55 per cent tax charge on the remaining fund. That is worse than the 35 per cent charge that used to apply to pensioners who died in drawdown before the age of 75 at which the old compulsory annuity rules took effect.
Most importantly, the new rules enable everyone to consider alternatives to transferring 100 per cent of their money to an insurance company. Self-invested personal pensions (Sipps), allowing savers to choose which shares, bonds or pooled funds to buy and sell to finance their retirement, have been open to everyone, including members of company and occupational schemes, since 2006. But the new rules extend this DIY pension concept beyond retirement.
Sipps attract front-end tax relief on contributions and allow tax-free lump sums equal to 25 per cent of the fund to be withdrawn for any purpose at retirement, just like any other pension. As people become more sceptical about traditional providers, Sipps are becoming more popular. Increased long-term saving is needed because, in a period of low interest rates and single-digit investment returns, massive sums of capital are required to generate even modest amounts of income. So the sooner you start, the easier it will be to achieve the desired result.
One particularly bold aspect of last month’s reforms may increase those inflows. Pensioners who can show that they have a secure income of at least £20,000 a year are now free to do whatever they like with the rest of their fund. Secure income is defined as that derived from annuities, final salary and state pensions. Few people who pass this test will take the rest of their fund at once because all pension withdrawals, apart from the initial lump sum, remain subject to income tax. But the new freedoms mean they could — to paraphrase the late George Best — spend most of their money on wine, women and song, while simply frittering away the rest.
In reality, few pensioners who opt to avoid annuities and remain invested will have enough saved up to pass the ‘minimum secure income’ test. So they will be restricted to withdrawing no more income from their fund than could have been paid by a conventional annuity. At present, that means about £6,900 a year for every £100,000 of fund held by a 65-year-old man — the idea being to prevent the fund expiring before the pensioner. For a woman of the same age and savings, the maximum drawdown based on annuity yields is just under £6,500, at least until a European Court ruling on equality takes effect.
Here and now, the sad fact is that most pensioners’ savings are far too meagre for them to take any unnecessary risks. But the Pensions Policy Institute reckons about three million people could reasonably consider making some use of the new drawdown rules — and a quarter of those questioned said freedom not to buy an annuity will encourage them to put more into a pension.
These new choices raise obvious risks, but it was high time the state stopped treating pensioners like babies. It’s our money, we saved it, and now more of us are free to decide how we finally spend it.