Budget 2014 - Treasury Contents

4  Pension reforms and savings

Increasing pension flexibility


106. Over the past twenty years, the previous requirement for retirees to purchase an annuity has been gradually relaxed. In 1995, income withdrawal up to the age of 75 was introduced.[186] This allowed retirees to defer the purchase of an annuity and instead to draw down personal pension savings within specified limits. This was known subsequently as an Unsecured Pension Arrangement (USP).[187]

107. The introduction of Alternatively Secured Pensions (ASPs) in 2006 allowed pensioners to draw down funds beyond the age of 75, further relaxing the requirement to purchase an annuity. In 2010, the Government stated that ASPs were not intended to be widely used:

    ASPs were introduced to provide an alternative to annuities for people who have principled objections to annuitisation, and were never intended to be widely used as an alternative to annuitisation. Consequently, the existing pensions tax rules effectively require most members of registered pension schemes to purchase an annuity by age 75.[188]

108. In 2011, the Government further reformed the operation of income drawdown by introducing a 'two-tier' system: capped and flexible drawdown. Capped drawdown had a withdrawal limit and requirement for triennial reviews before age 75 and yearly reviews after 75. Flexible drawdown permitted withdrawals of any amount subject to ensuring a secure income meeting the minimum income requirement as set by HM Treasury.[189]


109. The Budget announced some immediate changes to the pensions system. It said that, with effect from 27 March 2014, the Government would:

·  reduce the amount of guaranteed pension income people need in retirement to access their savings flexibly, from £20,000 to £12,000

·  increase the capped drawdown limit from 120 per cent to 150 per cent to allow more flexibility to those who would otherwise buy an annuity

·  increase the size of a single pension pot that can be taken as a lump sum, from £2,000 to £10,000

·  increase the number of pension pots of below £10,000 that can be taken as a lump sum, from 2 to 3

·  increase the overall size of pension savings that can be taken as a lump sum, from £18,000 to £30,000.[190]

The Chancellor said in his Budget speech that "these measures alone would amount to a radical change."[191]

110. Otto Thoresen, Director-General of the Association of British Insurers, shared the Chancellor's view. He described the immediate changes as "a big challenge for the industry and for the individual consumers affected".[192] In particular, he identified the speed at which the changes needed to be made as a challenge for providers, saying that "When you begin to make these changes to draw-down limits and the rest, the technology and systems implications of those changes are not insignificant".[193] He did, however, consider this challenge to be "manageable".[194]

111. The ABI's briefing on the Budget said that these changes would have "an immediate impact on customers who may be in the middle of purchasing an annuity."[195]Mr Thoresen told us that the industry's response to the immediate changes announced in the Budget had been "to extend cooling-off periods."[196] He added:

    [W]e have had to work in partnership with HMRC, because there are tax implications of unwinding these types of transactions. HMRC has been working hard since the Budget to clarify the many and various different situations that occur.[197]

112. On 27 March 2014, the Government stated that:

    […] people who have recently taken a tax-free lump sum from their defined contribution pension will be given more time to decide what they wish to do with the rest of their retirement savings and will not be put at a disadvantage should they wish to wait to access their pension savings more flexibly.[198]

In the light of this, HMRC issued guidance on 9 April 2014. It explained that it had:

    […] provided more information to help people who want to use the new flexibility. This information is for people who have:

    ·  received a tax-free lump sum on or before 27 March 2014

    ·  either cancelled an annuity contract within the cooling-off period on or after Budget day (19 March 2014) that was linked to that lump sum or not yet decided how to access the rest of their pension savings.[199]

On the same day, the FCA issued guidance to financial firms on how they would expect firms to handle the immediate changes. The FCA explained that:

    In light of these policy announcements, firms will to need to make changes to their operational processes and procedures. They will also need to consider how to treat those customers who are making decisions about their retirement income in this interim period. We are issuing guidance to outline our expectations of firms during this interim period.[200]


113. The Budget announced a package of changes to pension taxation that would take effect from April 2015. It described these reforms as "radical changes that will offer people more options in how and when they access their defined contribution pension."[201] Alongside the Budget, the Government published a consultation paper Freedom and choice in pensions, which set out the proposed reforms:

·  Removing the 55 per cent tax charge for full withdrawals from defined contribution pension savings

·  Treating any amount of income drawn from pension savings after the age of 55 as income and therefore subject to marginal rate of tax.

·  Removing the minimum income requirement for flexible drawdown

·  Removing the drawdown limit and review requirements associated with capped drawdown thereby bringing this type of income drawdown to an end.[202]

114. In addition, the Government announced that it would introduce a "guidance guarantee",[203] under which "all individuals with a defined contribution pension in the UK approaching retirement will be offered guidance at the point of retirement that:

·  is impartial and of consistently good quality

·  covers the individual's range of options to help them make sound financial decisions and equip them to take action, whether it is seeking further advice or purchasing a product

·  is free to the consumer

·  is offered face to face."[204]

115. These changes apply to defined contribution pensions. Members of public defined benefit schemes will not be permitted to transfer to a defined contribution scheme to take advantage of these reforms as, in the Government's view, this would "be unfair on both the taxpayer and remaining scheme members".[205] The Government is consulting on the circumstances in which members of private defined benefit schemes might be allowed to transfer. The Government is concerned that "large scale transfer (or anticipated transfer) of members of private sector defined benefit schemes to defined contribution schemes could have a detrimental impact on the wider economy".[206]

The importance of choice

116. The Government's pension reforms emphasise the importance of consumer choice. This was welcomed by many of those who gave evidence to our inquiry. Otto Thoresen, Director-General of the Association of British Insurers (ABI), described the increase in choice for consumers as "positive".[207] He also told us that the changes announced in the Budget created "the opportunity for a far more effective market for people retiring".[208]Chris Woolard of the FCA said that:

    The fact that there are now more choices potentially on the table for consumers at the point at which they either decide to purchase an annuity or do something different, we would be welcoming those changes.[209]

Chris Hannant, Director-General of the Association of Professional Financial Advisers (APFA), said that he thought that "people should have control of their money". He added: "I think you do not stumble into a substantial pension pot by accident and you should be rewarded for taking the responsibility to save".[210] For his part, Robin Fieth, Chief Executive of the Building Societies Association, said that "the concept of allowing people to have responsibility for their own money makes a lot of sense."[211] The IFS identified the advantages of the liberalisation announced in the Budget:

    It will allow people freedom to manage, and make choices over, their own affairs. It will likely increase the incentive to save in a pension.[212]

117. We asked Jane Vass, Head of Public Policy, Age UK, whether people could be trusted with their own money. She told us:

    I think people are generally very sensible. They are the ones that lose out if they do not take care with their money and I think people will generally make good decisions.[213]

Dr Ros Altmann, a pensions expert, told the Committee:

    […] this revolutionises the way pensions as a whole can work, both on the accumulation phase and on what I think will be a more flexible and gradual withdrawal, importantly leaving some extra money for social care that people are going to need but currently have not made any provision for.[214]

Joanne Segars, Chief Executive of the National Association of Pension Funds (NAPF), welcomed the changes but cautioned that "that there needs to be the right protections in place and the right support in place to help people make the expanded range of choices they have."[215]

118. The Committee notes that all witnesses welcomed the greater flexibility and choice provided by the Government's proposed pension reforms. We further note the Chancellor's commitment to "free, impartial, face-to-face advice", which will be important for many people for the reforms to work.

The responsibility of choice


119. We considered whether the increased choice for consumers at retirement was consistent with the Government's auto-enrolment policy. Auto-enrolment will ensure that every qualifying worker will have to be enrolled onto a workplace pension, and that both they and their employer will make contributions unless the employee actively opts-out.[216] The NAPF described the proposed pension reforms as "perplexing" when compared to the principles and assumptions that underlie auto-enrolment:

    Given that we have introduced auto-enrolment because people do find it very difficult to make these decisions, we have then said at the end people can have that freedom.[217]

120. The principle of freedom at retirement is not necessarily incompatible with the idea that people should be actively encouraged to save into a pension in the first place. Gemma Tetlow, of the IFS, said:

    There are perhaps two potential reasons for auto-enrolment. One would be that people are very short-sighted. Therefore, even if it is quite easy for them to make the choice to opt into a pension, they do not see the benefit of it because they discount the future.

    The second perhaps would be that it is quite a lot of hassle to get yourself organised with a pension. If the default is that you are making those contributions, it removes that hassle factor from you. To get rid of the requirement to buy an annuity later on, I think you would have to believe that people are somewhat less short-sighted at the age of 55 or certainly less short-sighted about the end of their lives at that point.[218]

121. Otto Thoresen did not, however, see any tension between auto-enrolment and the Government's pension reforms:

    I don't, actually. I have always felt, even before the events of the lastfour weeks, that the concept of auto enrolment and the nudge philosophy was fine when youwere trying to get people started on a savings habit. Making it easy for them to continue withthat savings habit is very sensible. But there was always going to be a point in the processwhere the individual had to start to understand that they were building up the assets on whichthey were going to have to live when they were no longer earning money through work, andthey were going to have to then start to think about their own personal situation: about thestate of their mortgage; their indebtedness; their ability to go on working in retirement;whether they had dependants; and whether they had elderly dependants. There is a long list offactors you have to start taking into account, which reflect the fact that you have stoppedbeing one of many who all broadly have the same savings need to being a whole lot ofindividuals who each have a different set of challenges to deal with when you arrive at aretirement decision. So that process of transition from inertia to ownership and personalresponsibility was something we were going to have to face up to, anyway. What this hasdone, though, is to raise the questions that would have come with that transition earlier. Thatis where I think the challenge is over the next 12 months.[219]

The Chancellor agreed that there was no contradiction between auto-enrolment and pension liberalisation:

    We want to see more savings. One of the very encouraging things about auto-enrolment is that 3 million more people now have pensions. The projections are that that will increase substantially. I think you make pension saving more attractive when you give people greater freedom.[220]


122. It is too early to tell how consumers will exercise the new freedoms given to them by these reforms. The OBR said that the impact of the reforms on the public finances was "particularly uncertain".[221] We asked its Chairman Robert Chote whether the ability to take pensions as a lump sum might raise household consumption and lower the savings ratio. He told us:

    We are assuming that, if you look at the set of pension and saving measures in total, there are effects going in both directions and, therefore, we have not made an explicit adjustment to the forecast for that. That is not because we are very confident that the answer is zero. It is because there are things going in both directions and we do not think we can be clear which way wins out.[222]

The assessment of the IFS was that:

    The liberalisation of pension rules is expected to lead to more tax revenue over the next few years. But that depends on highly uncertain behavioural assumptions about when people take the money.[223]

The FCA told us that it would use its Market Study to reach its own conclusions about the likely impact on the market.[224] The Chancellor himself acknowledged that the effects of the reforms were difficult to predict, saying:

    Let me be clear, it is a new area of policy. This is uncertain. We will see what happens.[225]

123. With increased consumer choice comes an increased burden of responsibility on consumers. Joanne Segars of the National Association of Pension Funds told us that the reforms "clearly expand the range of choices that people have, but we have also been very clear that with that choice comes responsibility".[226] Otto Thoresen of the ABI told us:

    The consequence of giving people choice and freedom to use their retirement assets in the way they choose is that they will make decisions and we will have to live with the consequences.[227]

124. Until consumers begin to use this overhauled market we cannot know what the impact of these reforms will be. The extension of consumer choice brings with it a number of uncertainties and risks. We examine these further in this chapter.


125. In his speech on the Budget, the Chancellor said that the pension reforms announced in the Budget were only possible because:

    [W]e have a triple lock on the state pension; more people are saving through auto-enrolment; and we are introducing a single-tier pension that will lift most people above the means test. That secure basic income for pensioners means that we can make far-reaching changes to the tax regime to reward those who save.[228]

The Minister of State for Pensions, Steve Webb MP, identified the single-tier state pension as a crucial element in facilitating the reforms, saying:

    In the past, Governments were concerned that if people had freedom over their pension pots, they would run them down too quickly and then depend on state support in later life. The single-tier pension provides a game-changing opportunity to rethink this model. With people receiving a full single-tier pension already clear of the basic means test, the state need be much less prescriptive about how people use their accumulated pension savings.[229]

The single-tier state pension will be introduced from 6 April 2016.[230] The reforms will:

    Restructure current expenditure on the state pension into a simple flat-rate amount, to provide clarity and confidence to better support saving for retirement. Those already over State Pension age when the reforms are implemented will continue to receive their state pension (and the Savings Credit, where applicable) in line with existing rules.[231]

126. One of the risks of the pension reforms announced in the Budget is that pensioners will exhaust their pension pot too early and need to fall back onto the safety net of the welfare state as a result. Dr Ros Altmann considered that that the reforms to the state pension reduced the risks to the public purse, but had not eliminated them entirely. She told us:

    I do think that people who have saved in a pension would typically not be the ones that will fall back on the state, but there is that risk. I accept that. I think the new single-tier state pension will be very helpful and it was an important part of the picture to try to reform the state pension system to have one that hangs together whereby it is safe to save. We still have the problem of council tax benefit and housing benefit. I do accept that, but at least the issue is less than it was before.[232]

Gemma Tetlow, of the Institute for Fiscal Studies, agreed that the risk was reduced but not eliminated:

    Virtually everyone will qualify for a single-tier pension that will be slightly above the level of pension credit. That does mean it slightly reduces the number of people who would be expected to end up on means-tested benefits in retirement relative to the current system. However, it does not mean that no one is likely to end up on means-tested benefits.[233]

She confirmed that there was a risk of additional future costs to the Treasury and that there remained a taxpayer interest in the impact of the reforms.[234] She said:

    Importantly, pension credit is not the only means-tested benefit that many pensioners qualify for. A lot also qualify for housing benefit and council tax benefit, which continue much further up the income distribution than pension credit does. The Department for Work and Pensions, for example, in their impact assessment for the single tier reforms, estimated that by 2060 under the single tier system about 15% of pensioners would still be eligible for some form of means-tested benefit and that excludes council tax support.[235]

127. We asked the OBR whether it had made any assessment of the likelihood that the pension reforms could have a detrimental impact on the public finances—for example, in the form of increased social care bills or increased housing benefit needs. Robert Chote told us that they had not made such an assessment, "partly because of the relatively short time horizon over which we look for these sorts of forecasts."[236] He added:

    I think it is a question that we will probably want to return to in the longer-term fiscal sustainability report, as to whether that is something we want to make any sort of an adjustment for, but I think the chances of much of that showing up as a serious pressure within a five-year horizon are relatively modest.[237]

128. Joanne Segars, Chief Executive of the NAPF, thought that the risk of pensioners exhausting their savings and needing to fall back on the state was limited. She told us:

    Evidence does suggest and, if we look at Australia, we do see that there the people are not blowing it all in one go. Clearly it is not possible to make exactly like-for-like comparisons, but we do see that financial responsibility grows with age but also as people's pension pots grow.[238]

129. The Government is currently undertaking a significant reform of the way in which long-term social care is funded. The reforms include a new means test threshold of £123,000 for government-funded long-term care. These reforms will come into force at the same time as the pension reforms in April 2015.[239] The interaction between increased choice in how to use pension savings and the reformed long-term care model is of great importance to the welfare of retirees and to the public finances. It is not yet clear how the two sets of reforms will interact. On the one hand, it may be that the pension reforms will assist pensioners in planning for their long-term social care needs. Dr Ros Altmann told us that she expected to see:

    […] a more flexible and gradual withdrawal, importantly leaving some extra money for social care that people are going to need but currently have not made any provision for.[240]

On the other hand, the pension reforms might tempt people to exhaust their pension pot to avoid being liable for the costs of their own long-term social care. Many savers may be unaware of the interaction between the pensions system and the social care means test. Joanne Segars of the National Association of Pension Funds explained:

    If you end up taking the money as one lump sum, that could count against you if you need social care benefits.[241]

Age UK pointed out that the means test for care allows local authorities to take into account undrawn pensions. It warned:

    Many people will be unaware of this, and it is unclear how the notional value of the pension would be calculated under the new regime. The impact of the 'deprivation of assets' rules if people withdraw savings for purposes which could be deemed inessential is also unclear.[242]

130. We asked witnesses from the OBR whether they considered it their responsibility to recommend that the Government reassess the overall cost of long-term care in light of changes in the behaviour of pensioners. Robert Chote said that that was not the role of the OBR, but added:

    What we want to do is to see what a sensible long-term projection of social care costs was. To date, we have done that very much looking on an assumption that is based around demographics rather than this sort of influence. I do not know whether, when we looked at it, we would think that was something that we could bring a particularly informed additional view to, but we will have a look at it.[243]

131. The Chancellor said that, following these pension reforms, the means test for social care would need to be revised:

    The current social care means test does not take into account […] the changes to the flexibilities around pensions and so we need to change the social care means test to take that into account. I am absolutely clear that we want to make sure that this does not have an impact.[244]

132. The full impact of the pension reforms on the long-term social care budget remains uncertain. The Government is right to require the long-term care means test to be revised in the light of these reforms. The Government has an understandable desire to have the radical changes to pensions completed as soon as possible. Because the reforms both to pensions and to long-term care come into force simultaneously, the revision of the long-term care means testshould be completed in time for those who may be affected by both these reforms to make informed choices.


133. The Government's consultation paper says that "Over the past few decades retirement has changed significantly".[245]The paper identifies increased life expectancy as one of the major causes of this change. It notes that:

    When the basic State Pension was introduced in 1948, a man reaching age 65 could expect to live for only 12 years, and a woman for 15 years. People are now living far longer. A man reaching age 65 in 2012 can now expect to live for 21 years, and a woman for 24 years.[246]

134. People can expect to live longer retirement, so they may have a period of retirement in which they are relatively active and then a period in which they have complex health and care needs. This may mean that alternatives to the universal single-life annuity product might be more suitable for some people. As Dr Ros Altmann explained:

    The annuity will cover against one risk. It is like buying a house and insuring against fire. The annuity will cover you against the risk of living a very long time, but there are many other risks in retirement that people face that certainly a standard annuity will not cover you for. It is like having fire insurance but then you get flooded or burgled and you do not have any cover. The standard annuity will not cover you against inflation or for a partner.

    This was one of the problems. The annuity market has been regulated as if annuities are a no-risk product suitable for everybody and that simply is not the case.[247]

135. Following the reforms announced in the Budget, those who do not purchase an annuity will need to manage their finances to meet their own needs. This includes managing the risk that they might live for longer than they expect. When asked how well consumers were able to estimate their own longevity, David Geale of the FCA told us:

    It is something very difficult and it is a very difficult question to even ask yourself: how long am I going to live? It is an answer that people perhaps underestimate, particularly when you build in the interaction of things like long-term care. Even if we make a reasonable assumption of how long we might live, we may not allow for the fact that we may need care provided over that period.[248]

Joanne Segars of the NAPF told us that there was evidence that people generally under-estimated their own longevity. She said:

    We know that people under-estimate how long they are going to live, women by four years on average and men by two years. We know that people under-estimate exactly how much they have in their pension pot and what exactly that will buy them and there are some quite complex issues to consider.[249]

The Institute for Fiscal Studies pointed out that:

    Even if individuals have thought carefully about their retirement and think they have accumulated sufficient resources to fund it, this may not actually be the case. While DB schemes insure their members against the risk of living 'too long' from the point at which they first join the scheme, DC scheme members do not get this insurance until they purchase an annuity.[250]

136. Until now there have been very strong incentives to purchase an annuity at the point of retirement. Creating greater freedom and choice in retirement will require individual consumers to consider the range of circumstances they may face, in particular relating to longevity. They will need to make informed decisions based on their personal needs and likely circumstances. For some consumers, these choices will require substantial guidance.


137. Creating a tax environment which supports innovation within the retirement market is a crucial feature of the proposed pension reforms. In its consultation document, the Government says that it expects the reforms:

    […] to stimulate innovation and new competition in the retirement income market, with providers creating new products to satisfy individual consumer needs and meet new social challenges such as funding care later in life […]. It will also expand the market to allow further development of existing products, such as deferred annuities.[251]

138. David Geale from the FCA thought that it was "too early to tell" how the market might respond to the changes, but considered that there was the "potential […] for product innovation".[252] Joanne Segars, of the NAPF, also saw this potential. She told us:

    What we would hope to see is more innovation in this market with products being developed that lead into long-term care products, for example, that are much more flexible and perhaps more accurately match the spending patterns that people face in retirement. I think there is potential here for more innovation and then it is for those pension providers […] to meet that new demand, to rise to that challenge.[253]

Chris Hannant, of APFA, expected to see "a market that generates products that are better tailored to the needs of the consumer".[254]

139. The financial sector's past performance in meeting consumer need through innovation was criticised by the Parliamentary Commission on Banking Standards, which found that:

    Banks have incentives to take advantage of these customers by adding layers of complexity to products. A good deal of the innovation in the banking industry makes products and pricing structures more complex, hindering the ability of consumers to understand and compare the different products.[255]

Demand and capacity to supply

140. As we have already noted, flexibility in pensions has increased over time. Nevertheless, those who choose to make use of this flexibility by drawing down their income are still in the minority. At present, sixteen times more funds enter annuities than income drawdown.[256] Now that pension flexibility is to be increased still further, a greater range of consumers will want to make use of that flexibility. As Otto Thoresen of the ABI told us:

    There are about 400,000 people retiring through this process every year. The vast majority of those, 60% of those, have small pots—the amounts involved are £30,000 or less. The fact is that for many of those individuals what is being created here is an environment in which they have far more choice.[257]

141. A wide range of annuity products are now available. Enhanced annuities sold as a proportion of all annuities has increased from 7 per cent to 24 per cent in 5 years[258]. Investment-linked annuities and escalating annuities, however, each constitute less than 5 per cent of the market.[259] It may be that the demand for new innovative retirement products will be for income drawdown products rather than annuities. As Dr Ros Altmann describes:

    When companies realise that there is a market or will be a market for products that have not yet existed. I do not know how long that will take but I certainly know that there are companies now working on ways of developing a kind of pension income type product. Drawdown and flexible drawdown, as they currently exist, are very expensive. The fees associated with those have resulted in them being unsuitable for small pension funds and very costly for any size pension fund, partly because of the restrictions that were on them and partly because of the way the market worked there was not a lot of competition anyway.[260]

Otto Thoresen described how he saw the market developing:

    I believe that the model that we will move to will be something that looks like cash for people with relatively small pots; and in the middle territory, an option that allows you to move into quite a simple and more balanced investment vehicle—call it draw-down, for the sake of no other label being available at the moment—which allows you to stay invested but still take income, and at a point when you are older, where you want the certainty that an annuity provides and the price of the guarantee is no longer as onerous, then you move into an annuitised position.[261]

Potential for mis-selling

142. The reputation of the financial industry has been damaged by considerable large scale mis-selling, with payment protection insurance being the most recognised example. The 1990s saw the mis-selling of personal pensions and free standing additional voluntary contributions.[262] We asked Otto Thoresen, Director-General of the Association of British Insurers, whether there might be a danger that pensions would be mis-sold, or poor advice given to consumers, as firms adjusted to the new arrangements. He told us:

    Because there will be more people making those decisions than there would have been otherwise, to say that there is no increase in risk would be an overstatement. But I do not see it as the most significant issue we have to deal with.[263]

143. For her part, Jane Vass of Age UK considered that it was the regulator's responsibility to guard against this risk:

    The onus should not be on the individual but on the industry and the regulators to ensure that products that come up are sensible. That will mean a much more interventionist approach than in the past.[264]

The Parliamentary Commission on Banking Standards made the following recommendation on early intervention by the regulator:

    The FCA has powerful new tools to intervene in products. […] Their use by the FCA will carry significant risks. How the FCA's new product intervention tools are used will be a key indicator of its success in taking a judgement-led approach. The balance between intervening too early, distorting the market, and too late, potentially allowing customers to suffer, will be a delicate one, and how these tools are used will be an indicator of the FCA's success in taking a judgement-based approach.[265]

This recommendation is as relevant to the pensions and insurance industries as it is to the banking sector.

144. The market is likely to adapt, offering a new range of financial products for those approaching retirement. It is crucial that these products are not defective. Were they to be so, the reputation of the financial services industry, which has suffered severe damage in recent years from large scale mis-selling, would be further tarnished.

145. The FCA has now been given new powers to intervene early, in advance of detriment occurring. In practice, this will be extremely difficult to accomplish without creating other forms of consumer detriment. In particular, it will be essential to avoid stifling market innovation. The use of these new powers will be a major test of judgement-based regulation.

The future of the annuity market

146. In 2013 the annuity market was worth £11.9 billion in total, with 353,000 annuities sold.[266] As larger defined contribution savings mature in 2012 the individual annuity market was expected to grow in the short-term to £23 billion by 2014-15.[267]In his Budget speech the Chancellor said "no one will have to buy an annuity".[268]After his speech, the share prices of a number of annuity providers fell, with "close to £3bn wiped off the value of listed firms".[269]

147. A central justification of the Government's proposals is that the annuity market is not working for consumers. As the Chancellor wrote in his Foreword to the reforms:

    The annuities market is currently not working in the best interests of all consumers. It is neither competitive nor innovative and some consumers are getting a poor deal. It is time for a bold, modern and progressive reform.[270]

The FCA's recent thematic review found that that 97 per cent of the market for open market standard annuity sales was held by just three providers.[271]David Geale, of the FCA, told us that "the thematic work has given us the conclusive evidence that the market is not working well for consumers and made the case for change".[272] Other witnesses also criticised the current performance of the annuity market. Dr Ros Altmann said of the FCA's study:

    I must confess that for people who have looked at the market, studied it and understood it in detail for a long time, it certainly did not reveal anything new. There is plenty more that could have been uncovered or investigated that I hope will still be so as the regulator gets to grips with what I believe is one of the most significant regulatory failures that we have seen in the financial system.[273]

Jane Vass, of Age UK, said that:

    Our concern has been well noted around the lower value end of the market, where we have been calling for liberalisation for some time. It has been a concentrated area. Rates have not been as good and we have been calling for a wider review of the whole decumulation area.[274]

Joanne Segars, of the NAPF, also agreed that the market was dysfunctional and said that:

    We produced a report two years ago now that showed that about £1 billion a year leaks out of the annuities market because people do make poor decisions or they do not get the right annuity for them.[275]

148. Following the Budget, market analysts produced a range of projections of the future size of the individual annuity market. RBC Capital Markets estimated the market would contract by 90 percent,[276] Barclays Equity Research said the market "could decline by two-thirds from £12bn to £4bn per annum within the next 18 months",[277] and Legal and General's Chief Executive Nigel Wilson estimated that the market would shrink by £2.8 billion a year with an overall decline by up to 75 percent.[278]

149. None of the evidence we received disagreed that these reforms would change the market, but as Joanne Segars of the NAPF pointed out to us, the effect of these reforms on the annuities market is not easy to predict. She said "the big unknown in all of this, of course, is how much demand there will still be for annuities in whatever form going forward".[279]Chris Woolard of the Financial Conduct Authority told us that predictions that the annuities market would effectively disappear due to the changes might be too pessimistic. He said:

    If you look at the experience of other countries, despite predictions there of markets sometimes disappearing on the back of certain changes, I think the case has often been that that is not what has happened. Switzerland is a very different regulatory environment. We ought to be careful about stretching the analogy too far, but if you look at Switzerland, they have gone through a very similar deregulation and still 80% of people who are retiring choose to buy an annuity there. I think we have to be very careful about predictions of doom.[280]

For his part, Otto Thoresen of the ABI expected that initial market contraction would be followed by recovery:

    In the next five to 10 years [you will see] lower levels of annuity take-up, but as people move through their retirement process, a recovery and growth again in the annuity market, because its positive aspects continue to be positive—the certainty it gives people and their ability to plan for the future, and they know that they will not run out of money.[281]

150. We considered the possibility that a reduced pool of annuitants might lead to poorer rates and further reduced demand for annuities. Dr Ros Altmann thought that this was unlikely:

    From the pricing perspective of annuities, certainly all the analysis that I have done, […] suggests that certainly the average annuity and the annuity that most people would have been buying that they had been rolled into from their existing pension provider now represents such poor value it is difficult to imagine the value worsening. […] It is difficult to see a case for standard annuities to become more expensive, so I would not be concerned that they do.[282]

Otto Thoresen, on the other hand, suggested that rates might continue to worsen under certain circumstances:

    A number of factors could lead to rates being poorer, but I do not think it is contraction in the market so much. We are already on a path that was leading to a different annuity market, anyway. The advent of the enhanced annuity providers who effectively underwrite the client at the point of their taking their annuity meant that you were beginning to get a healthier pool of customers in the standard annuity market. If you have a healthier pool of customers, they will live longer. If they live longer, clearly the rate that the market as a whole can offer will become less attractive. One factor certainly could apply: if the only people who take annuities are a particular type of individual that will shape the annuity pool and the pricing. But I do not think contraction in itself is likely to be the issue.[283]

He also highlighted the fact that current prudential rules mean that those who annuitise early lead to a greater capital cost to the insurer. He was optimistic that these reforms could reduce that cost and thereby improve the market:

    One of the challenges of writing annuity business is that you are offering effectively a 30-year guarantee. The Prudential regulator, not surprisingly, wants you to hold solvency capital to support that […]. If we can move to a point where people annuitise at the right time, you could see an improvement in the way the market operates.[284]

151. In its consultation, the Government stated that "those who continue to want the security of an annuity will be able to purchase one, either at the point of retirement, or at a later stage".[285] The Chancellor told us that:

    It is important to say that annuities would be the right product for many people after these reforms. They are not the right product for everyone. Some people want the certainty that annuities can provide.[286]

The FCA also said that annuities remained a suitable product for certain consumers.[287] Joanne Segars agreed, saying:

    Fundamentally there are large number of people who, in retirement, want a regular income. They want that certainty of a regular income with some inflation-linking perhaps, with the ability to leave something to their spouse or partner. When you ask people what they want, lots of people say, "What I want is a regular income for the rest of my life and I can leave something to my spouse".[288]

152. The impact of these reforms on the annuity market will only be known after a number of years. Increased flexibility and choice in retirement will only benefit consumers if an active and innovative market offers a range of products, which should include annuities, to suit individual requirements.

The guidance guarantee

153. The Government's consultation paper welcomes "the recent statement by the Association of British Insurers (ABI) committing pension providers to provide, at the point of retirement, 'a conversation for customers with their pension provider or an impartial advice or guidance service about their retirement options.'"[289] It describes this commitment as "an important step forward in improving the guidance that consumers want and need."[290]The Government proposes to legislate on a "right to financial guidance" for people at retirement.

154. Building on previous work, the ABI made a commitment that, by summer 2015, its members would provide:

    A conversation for customers with their pension provider or an impartial advice or guidance service about their retirement options. This conversation will include a high-level overview of alternatives to annuities as people approach retirement.

    A comparison of annuity quotes for customers, whereby all providers will offer a comparison, or introduction to an intermediary who will deliver the comparison, early and prominently in their retirement process. The comparison will be offered as an integral part of the process not as an optional extra.

    Ask all customers for information about their health and lifestyle, which they can use to shop around for an enhanced rate.[291]

155. The Chancellor told us that he did not think "people are getting […] particularly good guidance at the moment".[292] The Government proposes that all individuals with a defined contribution pension be offered guidance that is:

·  impartial and of consistently good quality

·  covers the individual's range of options to help them make sound decisions and equip them to take action, whether that is seeking further advice or purchasing a product

·  free to the consumer

·  offered face to face.[293]

156. This guidance will be crucial to ensuring that consumers are empowered to make the best possible use of the flexibility offered by the Government's reforms, given the imbalance of information between many of the buyers and sellers of financial products, and the complexity of decisions which relate to tax liabilities, care costs and interaction with certain Government means-tested benefits. Joanne Segars emphasised the complexity of the retirement choices that consumers have to make:

    It is the interaction with a much wider set of issues than just purchaser and seller. It is the interaction with the tax system and the interaction with the social care system.[294]

Guidance also helps to ensure that consumers are not only better placed to avoid mis-selling but also to contribute to creating discipline within the market through competition. As the Parliamentary Commission on Banking Standards found:

    Empowering consumers to make better decisions about the merits of banking services is not simply a means of avoiding future scandals. Informed consumers are better placed to exert market discipline on banks more generally and, in doing so, encourage banks to compete on price and service.[295]

157. We set out below the key issues that the Government and the FCA should address in developing the guidance guarantee and the standards which will underpin it.


158. In his Budget speech the Chancellor described the 'guidance guarantee' as:

    A new guarantee, enforced by law, that everyone who retires on these defined contribution schemes will be offered free, impartial, face-to-face advice on how to get the most from the choices they will now have. [Emphasis added][296]

On the other hand, the Government's consultation paper said that the Government would introduce:

    a new guarantee that all individuals with a defined contribution pension in the UK approaching retirement will be offered guidance at the point of retirement. [Emphasis added][297]

When we asked the Chancellor about this, he described the difference between advice and guidance as "a technical distinction", and said that his Budget speech needed "to communicate in English so that people watching it can understand what is meant". He added:

    The issue that you have raised was not something that the consumer groups have had a problem with. They have all understood what exactly was meant. I think the general public have understood what was meant as well, which is the purpose of the Budget speech.

159. The distinction between 'advice' and 'guidance' may be a technical one, but it is nevertheless important. Chris Woolard, of the FCA, told us:

    Advice, with a capital A, and guidance are absolutely not the same thing in terms of how we approach the rulebook for the industry. Advice, in terms of regulated advice, carries with it a series of guarantees and protections that are provided around it.[298]

Dr Ros Altmann said the word advice was "a problem",[299] while Joanne Segars, of the NAPF, said that "consumers tend to confuse 'Guidance' and 'Advice'".[300] The FCA added that:

    Within our rulebook full-blown regulated advice is pretty well understood by both firms and consumers when they go and get it. It feels like a very formal process. Similarly, so-called execution only, where you decide to do something completely yourself, is pretty well understood by people. The piece in the middle is often quite murky for the firms themselves sometimes but definitely for consumers.[301]

160. The FCA acknowledged that there was a clear difference in liability for consumers who decide to purchase a financial product after having received "advice" and those who do so having received "guidance". In the case of guidance, Chris Woolard told us:

    The responsibility rests with the consumer and the risks around making a decision rest with the consumer in a guidance situation.[302]

The implication of this is that consumers who receive guidance will have no recourse to the Financial Ombudsman Service. The providers of the guidance would only be liable:

    […] if the firm or whoever is providing that guidance has misled somebody, but it would not be about the decision that is made.[303]

It is therefore crucial that consumers should have a clear understanding of whether they are receiving advice or guidance, and the extent to which they are able to seek redress if things go wrong.

161. There is a clear distinction in financial services between regulated advice and guidance. Although what was proposed was clear in the Budget Red Book and in the consultation document, the Chancellor's Budget statement on this point could have been better phrased.

162. The guidance made available to consumers must explain what, if any, protection they may have in cases of poor guidance.


163. Consumers approaching retirement are likely to use a range of sources to help them make decisions. The time at which guidance is offered is likely to affect the extent to which consumers benefit from that guidance and the level of influence it has on their decisions. The ABI's current practice is to begin communicating with customers approaching retirement 12 months in advance of their stated retirement date. Otto Thoresen told us:

    I think there is a tendency at the moment in this discussion to have in one's mind the idea that this happens about a week before you retire. The retirement code that we have been running within the ABI starts a year before. This process has to start earlier.[304]

164. The greater opportunity and complexity that many people are anticipating within the retirement market means that financial decisions are no longer a 'one-off' occasion. Instead, many retirees will be responsible for managing their finances as their requirements and circumstances change throughout their retirement. Jane Vass of Age UK emphasised the need for ongoing advice throughout retirement:

    If you are not taking an annuity, there is an initial decision to make, but then you will need to look at your finances regularly. There needs to be some provision for ongoing advice that potentially links up with advice earlier in life.[305]

Dr Ros Altmann suggested that guidance should be delivered while people are still in employment, and that this could be achieved by linking it to auto-enrolment. She explained:

    I would expect that this could be facilitated in the workplace alongside auto-enrolment. We are basically talking about financial planning and if there was some mechanism to incentivise employers, who have to put people into pension schemes anyway, to help them with this kind of financial planning and then perhaps trustees, I think that could be helpful.[306]

165. The guaranteed guidance must be available to people well in advance of their retirement to help their decision-making.


166. The Government's consultation paper states that, in developing the standards for guidance, the FCA will work "in close partnership with consumer groups, the Pensions Advisory Service, and the Money Advice Service".[307]

167. Our own inquiry into the Money Advice Service, on which we reported in December 2013, left us with serious concerns about the way in which the MAS was carrying out its role.[308] We considered carefully whether to recommend that the MAS be abolished. We recommended instead that the Treasury commission an independent review of the MAS, and that this review should report by summer 2014. The then Financial Secretary to the Treasury, wrote to us on 2 February 2014 to say that the Government had accepted our recommendation for an independent review.

168. Given that the Money Advice Service has been asked by the Treasury to play a role in developing the standards for financial guidance at retirement, it is even more important that the independent review of the MAS is completed quickly.


169. The Government's consultation paper says that it will introduce a "new duty on pension providers and schemes to deliver this 'guidance guarantee' by April 2015".[309]It also, however, requires that the guidance should be impartial.Otto Thoresen said that there was scope for third party organisations to deliver the guidance on behalf of firms:

    I think the industry could deliver this; I have no doubt about that. We could deliver this, and deliver it cost-effectively. However, the test we would have to pass is one of genuine and demonstrable impartiality.[310]

    I think my members—the insurance companies—would say that they have built strong relationships with our customers and they would want to continue to service those customers well. However, there are a number of ways that we could choose to try to deliver this cost-effectively and consistently, which perhaps would lend yourself to being a bit more radical about the way you think about doing this. We already have a couple of vehicles out there that have been built. The Money Advice Service has had some challenging interrogations from this group and a sub-committee of this group, but the Pensions Advisory Service is also a very strong organisation. There must be ways that we can also use existing capability to get there faster than if we have to build it all from scratch.


    If it was delivered through a third party or a utility, it would be far more straightforward.[311]

For her part, Dr Ros Altmann was clear that providers should not deliver guidance, saying:

    The FCA needs to get to grips with how we can deliver cost-effective, impartial guidance or advice that has minimum standards and no product sale link at all. The idea that some insurance companies suggested straight after the budget that their own sales staff or telephone operators, whatever they are called, could provide this guidance is a non-starter for me. This has to be independent.[312]

170. It is essential for the success of the pensions reforms that the guidance offered under the guidance guarantee is trusted by those who use it. The guidance offered under the guarantee must therefore be demonstrably impartial. It must certainly not be biased in favour of any particular product type or provider.


171. In the Budget the Chancellor provided £20m over the next two years to fund the creation of the guidance guarantee.[313] The Chancellor described this as:

    Literally a development fund, to develop over the coming year the guidance package […] then, of course, going forward the guidance will be a cost borne by the industry and I think that is understood.[314]

In his Budget speech the Chancellor said the guidance service would be free.[315] He clarified this statement in evidence to us, saying that the guidance would be:

    Free at the point of use, so that costs will be borne by companies, by the industry, and that are one of many costs of doing business. I think it is more than outweighed by the benefits to the industry of what I am offering.[316]

172. The running costs of the guidance will be determined by the form it takes and who delivers it. Some estimates put the potential costs as high as £120million a year.[317] The ABI said this "would not seem an unreasonable estimate" and the NAPF said "it looks like it might be in the right ballpark".[318] There was also agreement between NAPF and APFA that these costs would ultimately be passed on to the consumer.[319] Otto Thoresen told us that "It will have to be paid for, and it will be paid for by the customer in the end."[320]

173. It will be important for the success of this policy that people receive high quality guidance. As well as being of value to the individual it will have public policy benefits. People need to be aware that while the guidance is to be free at the point of use, the costs of firms providing it will borne by consumers. It is crucial that people grasp the value of this guidance. We therefore recommend that the full average cost of the provision of the guidance by firms be estimated and disclosed to consumers.


174. The 'guidance guarantee' for those approaching retirement is not being created in isolation. The Money Advice Service and Pension Advisory Service have existed for some time. The Government has also legislated to ensure local authorities provide "comprehensive information and advice about care and support services in their local area" in the provision of long-term care.[321]

175. The aim of the guidance will not be final product selection. As the FCA described:

    I think the purpose of the guidance would be to put those questions in people's minds. As I say, it can't decide the product for them but what it can do is tell people the implications of various decisions, "If you choose to take the money and you run out of money then effectively that is a decision for you and, equally, the implications of things like people on average live for X years and so on from your age", and put those thoughts, where it is factual, in people's minds.[322]

176. Age UK said that "there are overlaps with advice for care" and that it was important to link between existing providers in order to offer retirees a comprehensive service:[323]

    It will be important to link up web advice from people like the Money Advice Service through to telephone advice from the Pensions Advisory Services through to more detailed face-to-face advice. That will need a very strong framework. It will need strong standards but, very importantly, it will also need good ways of handing off people between the different parts of the system.[324]

177. Age UK also called for guidance to go further than currently envisaged:

    Guidance, in this area, may need to go much further than just the financial issues. For example, issues around whether or not you should retire at all; what to do about housing or debt; the factors you need to take into account. Guidance has a very clear role to play in that, but guidance also has a role in telling people when they should be taking regulated advice.[325]

178. The 'guidance guarantee' is not the only Government sponsored guidance being designed for pensioners or those who are approaching retirement. These schemes should operate in concert to help people make informed decisions about what is right for them in retirement.

From guidance to advice

179. The provision of guidance, and the complexity of the new market, is likely to trigger a greater requirement for further support and financial advice. The FCA also acknowledged this:

    What that will not be and what will still be the case for many people, I suspect, is that it is then appropriate for them to go on and get their own independent Advice.[326]

180. An increased demand for products, in what will be a more complex market, is likely to also increase demand for professional financial advice. Joanne Segars told us that there was already a problem with the affordability of that advice:

    Very many people simply cannot get that advice. The pension pots are too small for them to be profitable for advisers or brokers to want to deal with and that is not just a problem for individuals. It is a problem for small trust-based pension schemes trying to put annuity broking services together or trying to provide support to their scheme members.[327]

Chris Hannant, Director-General of the APFA, acknowledged this problem, saying: "I know there are firms out there who can provide advice cost-effectively at pension pots less than £10,000, of about £5,000, but there is a problem at the bottom end." On the question of whether there was sufficient capacity in the advice market to cope with these reforms, he told us:

    If everyone who retiring next year was to seek full advice I think there would probably be a challenge on capacity. […] It is a question of scaling up. There would need to be a clear signal early in terms of what is expected in terms of the industry to prepare. I believe there is scope in the industry to deliver advice more cost-effectively through the use of more junior staff and overseen by fully-trained, qualified advisers.[328]

181. Otto Thoresen expected that there would be an increase in demand for advice, but suggested the prospect of new technologies creating additional capacity and the potential to bring down costs:

    This change will increase demand for regulated advice around decisions at retirement, and accelerating some of the existing work going on within the FCA about how that advice can be delivered safely and economically using new mechanisms and new technologies is an important part of making this whole system work well for society. I would like to think that we can also take that opportunity to try to move some of this stuff forward faster.[329]

182. The APFA similarly highlighted that:

    One of the things we are seeing is greater use of technology that can help lower costs and there are some firms out there who are looking to try to provide an entire computer-generated advice process. In the future that may help, although a lot of people still want the face-to-face service. Yes, there is a challenge for our sector to become more efficient and reduce the cost of advice.[330]

183. The FCA is currently undertaking work to ensure regulation does not limit innovation in this area as the Treasury Committee heard in February this year:

    We should encourage the innovation in this area. Ultimately we will have to take the decision, "Is this good enough?" but I do not think we should let the perfect be the enemy of the good when the fundamental problem is the cost of providing advice at all. I would rather have some good automated advice that gets to reasonably simple, understandable products than to have had hidden trail commission in the past.[331]

184. The regulator has assured the Committee this issue will be consulted on shortly but highlighted their concerns that:

    It is a real concern because the distinction between a product which is advised on the web and execution-only on the web is not a distinction that people naturally and easily can determine. We are spending quite a lot of time talking to the industry about whether we need to revise our guidance to make products fall very clearly into one class or the other.[332]

185. The Chancellor's commitment was for face-to-face advice to be available. Evidence to the Committee from a number of witnesses suggested a desire to use other channels. These will be appropriate for some customers but, in line with the Government's pledge, it is important that at least for those who choose face-to-face guidance this is provided without financial detriment to the customer.


186. The pension reforms announced by the Government are welcome, and also transformational. Consumers will need considerable support in navigating a market which is undergoing major change and in which consumers are likely to be offered an array of new products. The Committee recommends that the proposed guidance under theguarantee observe the following principles. It should:

·  Be demonstrably impartial as to providers and type of product;

·  Include at least an initial opportunity for face-to-face guidance;

·  Be free at the point of use, with the costs of such provision made transparent;

·  Make clear to every consumer exactly what is being offered, the limitations of the guidance, and what protection it gives consumers in the event of detriment;

·  Be offered from at least 12 months in advance of the consumer's stated retirement date; and

·  Be co-ordinated with Government-sponsored guidance relating to long-term care.

Impact on the wider economy


187. An important part of the Government's consultation is whether and to what extent these pension reforms should be open to private defined benefit scheme members.[333] At present, members of these schemes can transfer their accrued funds by converting them into a cash equivalent transfer value.[334] The Government is consulting on whether this should continue to be permitted.

188. Michael Saunders, of Citi, told us that allowing defined benefit members the right to transfer would be likely to have a greater impact on the economy than that currently anticipated within the annuity market:

    It would be basically the same effects on flows by fewer annuity purchases, potentially more spending, but on a much greater scale, because in aggregate the DB pension schemes are closer to maturity and obviously much larger than the DC schemes.[335]

The IFS said that the extension of the reforms could destabilise the risk-pooling of defined benefit schemes:

    I think part of the issue there is that, from the beginning of the defined benefit system, you have risk sharing. For example, if I hit 60 and I am pretty ill and I think I am not going to live terribly long, I have a very big incentive to take my money out of the DB scheme and make use of this ability not to have to buy an annuity. If I do that and my DB scheme is funded on the assumption that a proportion of people will die early, which they are, then that requires additional contributions from everyone else or reduced benefits; probably additional contributions.

    There is a danger of undermining the funding structure of DB schemes if you allow those who will benefit most from not having an annuity or a pension to move out early. I can understand the caution here because I think you do risk the schemes being selected against by those who do less well from the schemes. I think that is a fundamental part of the risk sharing that defined benefit schemes provide.[336]

189. Joanne Segars said that, while transfers are currently permitted, the impact of extending the reforms was uncertain:

    Of course, at the moment people do have the right to shift their DB pot into a DC scheme and then in future they will be able to do what they want with that. At the moment, of course, they have to abide by the rules as they current exist and schemes do use that at the moment as a sort of de-risking valve, but we need to consider what the likely demand might be for members of DB schemes and what the impact might be flowing forward. As I said, at the moment it is too early to say. We are still working through those numbers with our members.[337]

She also said that the reforms would require changes within the schemes' asset management and that the NAPF would need to work with schemes and the Treasury to model the impact:

    We need to work with our members to find out and work through what the impact would be on pension funds' investment policies if these changes were extended to defined benefit pension schemes. At the moment, I think it is too early to tell. We need to crunch through the numbers. We need back from Treasury some of their modelling so that we can work with the Treasury to help understand what the impact might be.[338]


190. The greater choice that the pension reforms allow is likely to lead to changes in the investment and consumption patterns of people in retirement. Economists from whom we took evidence did not predict any damaging consequences to the macroeconomy from these reforms, but did suggest that they might have an effect on specific markets. Robert Wood, of Berenberg Bank, said:

    I think it would be a small positive for consumption. Frankly, I don't know how big the number would be but I think directionally it would be positive for consumption.[339]

    One key question is how much money flows into the housing market in one way or another now these funds can be allocated to different investments other than just annuities, and of course the gilt market.[340]

Michael Saunders, of Citi, agreed with this assessment for the short term, but suggested that the economic impacts of the changes might not be felt for some time:

    The effects near term on the economy are small but they build over time because most of the DC schemes are not yet at the point where people are retiring off them. You can see that the flows out of them would be much larger if you go forward 10 or 20 years.[341]

191. The principal cause of the OBR's uncertainty was the ability of consumers to transfer between assets quickly:

    One reason to underline the uncertainty here is how quickly people can move relatively large amounts of money from one form of holding wealth to another.[342]

192. The FCA warned that where customers concentrate their wealth in one asset class they increase their investment risk:

    If you have a strong level of investment into the wider property market, there are issues there if people are over-extending into that space. Clearly, for someone who is taking a pot in cash under potentially these reforms, one of the questions you think about, whatever they are investing in, whether it is property as buy-to-let or whatever it might be, is what the overall balance of risk is they are taking. Clearly, in any product, someone who says, "Great, I am going to take all of my pot and I am going to put it all into one thing", is running an awful lot of risk and, if you had a significant amount of money to invest in those circumstances, we would want them to consider taking independent advice.[343]

193. Reliance on housing as a single investment asset class may be of concern as house prices have a history of peaks and troughs. This volatility was evident when average UK house prices fell by 20 per cent, from £186,044 to £147,746, in the sixteen months between October 2007 and February 2009.[344] Similarly, at the beginning of the 1990s, the Nationwide House Price Index recorded a fall of 20 per cent between Q3 1989 and Q1 1993.[345] Following this fall, prices did not begin to recover until the beginning of 1996.[346]As discussed earlier, regional variation also affects house prices. House prices remain 22 per cent below their inflation-adjusted peak across the UK, but only 6 per cent below their peak in London.[347] The impact of inflation and changes in rentsmay add further complexity and uncertainty to any assessment of the returns available on housing as an investment.

194. When asked about the potential risk of over-investment in housing the Chancellor said:

    The OBR was aware of the policy when they did the house price forecasts and the impact of buy-to-let historically, although you made the point about the future, has been a bit more limited than perhaps the hype would lead you to believe on house prices. But as I say, I don't think that would be a reason to not go ahead with pensions flexibility.[348]

195. There are risks to individuals and the wider economy if people decide to concentrate their savings in a single asset class such as residential property. Contrary to widespread perception, residential property can be a volatile asset class and prone to large falls in value.


196. Annuity providers and pension funds are intended to be important sources of long-term investment for the UK economy. The Government has a target of securing £20billion of investment over the next decade.[349] The Chancellor acknowledged the UK's structural weakness in generating future infrastructure investment:

    There is a structural issue for the UK and there are a whole range of things that we can do to try to improve that, such as reforms in the financial system, to the way things are financed […] by trying to get pension funds invested in infrastructure.[350]

197. We asked witnesses whether the pension reforms announced in the Budget might have an effect on infrastructure investment. Robert Wood, of Berenberg Bank, suggested that the effects would not be felt for some time:

    Infrastructure spending is one thing that exercises a lot of people, given that part of the plans for the next few years was to have the providers of these annuities, these pension providers, allocating funds to help infrastructure. This money won't just disappear—people currently have a lot of money invested in annuities—but it does mean that over the next 20 or 30 years, presumably as flows into annuities fall, that pot of money available will also become less significant.[351]

Joanne Segars told us that there would not be an immediate impact on investment, saying: "For the moment our members remain very interested in investing in infrastructure".[352] For his part, Otto Thoresen thought that "there will be an impact on infrastructure and insurer investment in the wider economy in the years ahead.[353]

198. The Chancellor believed that support for infrastructure was unaffected following the announcements of these reforms:

    The encouraging response I have had from my own conversations with leading players in the industry is that they are still interested in investment in infrastructure because of the predictable and stable returns that that can provide.[354]

Relationship to other savings reforms

199. The Budget announced the introduction of a New ISA (NISA), which will be "a simpler product with equal limits for cash and stocks and shares", to be introduced from July 2014. The annual investment limit for the NISA will be £15,000 a year for both cash and stocks and shares, and savers will be able to transfer previous years' funds from stocks and shares ISAs into cash ISAs. The Government also announced that peer-to-peer loans would be eligible to be held in ISAs, and that all restrictions around the maturity datesof securities held within ISAs would be removed.[355]

200. These changes amount to a considerable increase in the flexibility of ISAs. Taken together with the increase in the flexibility of defined contribution pensions, they suggest that the lines between pensions and other kinds of saving are becoming blurred. David Geale of the FCA told us:

    I think people have always been able to look at different methods of saving for their retirement and pensions should not be seen as exclusively that route. Is it becoming more so? Yes, I think that is right, with greater flexibility. There is also the hope that people may save more over that period, be that through ISAs, pensions or other routes.[356]
Table 6: Pension schemes - annual and lifetime allowances since their introduction, £ thousands
  Lifetime allowance Annual allowance
2006-07 1,500 215
2007-08 1,600 225
2008-09 1,650 235
2009-10 1,750 245
2010-11 1,800 255
2011-12 1,800 50
2012-13 1,500 50
2013-14 1,500 50
2014-15 1,250 40

Source: HMRC

201. Changes made to the allowances and reliefs applied to pensions in recent years have made it more likely that people will suffer through paying tax more than once (sometimes known as double taxation) on the income they use to finance pension saving in the first place, the capital gain or interest on that money, or the income received subsequently from the pension. In particular, the introduction in 2006 of annual and lifetime pension allowances, and their recent substantial reduction (see Table 6), have limited the amount of pension a person can save which is eligible for tax relief. This will have increased the amount of income subject to such 'double taxation'.

202. Nor have changes to the pensions taxation regime removed the fact that some income attracts no tax at all when it is saved towards a pension. The tax-free pension commencement lump sum (usually up to a quarter of an individual's pot) will continue to be available following the implementation of the Budget changes, as will the exemption from national insurance contributions applied to payments made by employers into pension schemes. For her part, Joanne Segars broadly agreed with the principle of savings being taxed only once, but favoured keeping the tax-free lump sum. She told us:

    We would certainly want to keep some that is not taxed at all, yes. We would like to have rather more of it that is not taxed, but we would certainly like to keep the tax-free lump sum because, again, if we are talking about the incentives for people to save for retirement in the first place, that is a big incentivisor.[357]

203. Mr Mortimer-Lee noted that pensions saving was effectively subsidised over other forms of saving:

    One of the questions I have about this is in the past you got a tax break and the quid pro quo was you had to invest it in a pension in the form of an annuity. Now that you don't have to invest in an annuity, what is the rationale for the tax break? What makes this form of saving tax privileged? I think there are a number of questions that are raised. One is DB versus DC schemes and the other is why are we tax subsidising this form of saving and not all other forms of saving?[358]

Gemma Tetlow spelled out in more detail the tax advantage offered to pension saving:

    The thing to be clear about is exactly what we mean by the more tax-favoured bit of pension saving. You do not pay any tax on your contributions to a pension. You do not pay any tax on the investment returns in your fund, but then you pay tax on the way out. Most of that we would not think of as over-generous tax-favouring of pension saving. There are strong reasons, as outlined in the Mirrlees Review, for not taxing the normal return on savings and ISAs have a similar feature, although they are taxed and then exempt in the two other places.

    It is not that bit of tax treatment of pensions that we were focusing on as being more generous than other forms of saving. It is other elements, such as the fact that employer contributions to pension schemes avoid all national insurance contributions as well, which obviously never get charged on the way out either, and the fact that you can take 25% of your pension fund completely tax free. That is 25% that never gets taxed at any point. It is those elements that seem much more generous relative to any other form of savings vehicle that you could think of.[359]

Paul Johnson, Director of the Institute for Fiscal Studies, argued that:

    We would not suggest that[…]pensions should be taxed very heavily. They should not be taxed twice. It is just that they should be taxed once and, as Gemma said, the case for taking a quarter of it up to £300,000 or something, completely tax free—never been taxed on the way in, not taxed when it is there, not taxed on the way out—has always looked a little difficult but, given that you can now take this as a lump sum anyway and pay normal tax, the case for that is probably reduced. I think it is important to be terribly clear that we are not suggesting with any of this that we want to move away from or that the Government should want to move away from exempting from tax contributions on the way in because that is just part of a—

    Mr McFadden: Exempting pensions from tax contributions.

    Paul Johnson: Exactly, because I think that is just part of sensible system for taxing savings; you are only taxed once and you are taxed on the way out. That seems like an appropriate way of taxing savings.[360]

204. Robin Fieth, Chief Executive of the Building Societies Association, thought that there was merit in the principle that people should be taxed only once on their savings.[361] Chris Hannant, Director-General of APFA, broadly agreed with this, but added:

    The ISA currently will offer far more flexibility, but I think it is right that people are nudged towards a framework for the long term so it is there until you are 55. I also think the taxation on the drawing down rather than paying in is important. Good tax planning will help negate the Lamborghini problem because it will be you are better off spreading that pension pot over a number of years rather than taking it all at once.[362]

205. Taken together, the changes announced in the Budget to ISAs, as well as thereforms to the taxation of defined contribution pensions at retirement, amount to a substantial increase in the flexibility available to savers. As this flexibility increases, ISAs and pensions will become increasingly interchangeable in their effect. In the light of this, the Committee recommends that the Government set out comprehensively the approach it intends to take to taxation of all forms of saving. This should include an examination of the merits of moving further towards taxing savings once, the scope for bringing closer together the tax treatment of ISAs and pensions, and the appropriateness of the present arrangements for the pension tax free lump sum.

Pensioner bonds

206. The Budget announced that National Savings and Investments (NS&I) would "launch a choice of fixed-rate, market-leading savings bonds for people aged 65 orover, available from January 2015 and allowing inflows of up to £10 billion."[363]For the purposes of costing this measure, the centralassumption made in the Budget was"that NS&I will launch a 1-year bond paying 2.8% gross/annual equivalent rate (AER) and a 3-year bond paying 4.0% gross/AER, with an investmentlimit of £10,000 per bond."[364] The Government will announce precise details of these bonds in the Autumn Statement later this year, taking account of the "prevailing market conditions at that time".[365] The Government also announced that NS&I's Net Financing target would be increased:

    NS&I will have a net financing target of £13.0 billion in 2014-15, within a range of £11.0 to £15.0 billion. This will allow NS&I to support savers with a choice of fixed-rate market leading savings bonds for people aged over 65 from January 2015, taxable at the marginal rate, and raise the Premium Bond limit from £30,000 to £40,000 from 1 June 2014.[366]

207. This announcement seems to amount to a change to the way in which the rates on NS&I savings products are set. NS&I's own website describes the process for setting its rates as follows:

    We set our rates to balance the interests of three groups: our customers—offering them a fair rate; taxpayers—with our remit to raise cost-effective finance for government; and the wider financial services sector—supporting stability.[367]

We took evidence from the Chief Executive of NS&I, Jane Platt, and its Partnership Director, Steve Owen, on 4 March—two weeks before the Budget. We asked Jane Platt whether encouraging saving was part of NS&I's remit. She told us:

    That is no longer there in terms of the objectives or the operating framework of NS&I. We are now tasked with balancing the interests of the customer, the taxpayer and broader financial stability.[368]

She described this as the "balance of three".[369]

208. In the light of NS&I's responsibility to its customers, we asked why NS&I had reduced the rate offered by its Direct ISA from 1.75 per cent to 1.5 per cent. Jane Platt told us:

    We decided to cut it because if we had left it where it was […] we would have been at the top of the market and we are not positioning our products at the very top of the top quartile on the usual basis.[370]

On the question of why NS&I had withdrawn index-linked savings certificates, she said:

    The last time we had index-linked savings certificates on sale was not this summer but the summer before. We put an offer on sale that was planned within the context of the net financing envelope that we had for that particular year, so we were able to have index-linked savings certificates on sale for close to four months. During that period we raised the amount of money that we had wanted to raise, and then closed the offer.[371]

We understood these answers to mean that NS&I was prevented from offering market-leading rates and products, which would be in the interests of its customers, by the other two elements of the "balance of three":the constraints of its net financing target and—to a lesser extent—the interests of the wider financial services market.

209. The Government's Budget policy costings document acknowledged that the cost of raising finance through NS&I would be greater than the cost of usual borrowing decisions:

    The costing is calculated by estimating the increased cost of the NS&I product over usual borrowing decisions, which it is assumed would raise the money through a mixture of Gilts and T-bills. This is the difference between a pre-measure scenario where the government raises £10 billion through the DMO, and a post-measure scenario where £10 billion is raised through the new NS&I bonds rather than through gilts.[372]

210. We asked Robin Fieth, Chief Executive of the Building Societies Association, what effect the introduction of these bonds would have on other providers in the savings market:

    […] there are some imponderables in that. If we start at the headlines and go slightly wider than the pensioner bonds, if I may, to the NS&I target for the next year of £13 billion. If we took that as the share of net cash savings market for the current year, on our assessment it is about 25% of the net cash savings market. It is a fairly large chunk and when you then look at the rates that the pensioner bond is offering, which are markedly higher than the best rates available for similar products in the market at the moment, then we can certainly anticipate some impact on the savings market.[373]

On the question of whether the introduction of "pensioner bonds" would increase household savings, he suggested that "past experience says that it probably will not have a huge effect".[374] We asked what the effect on building societies would be if people over 65 chose to move existing savings into pensioner bonds. He told us:

    That is certainly one of the scenarios we are considering and not just building societies because it is the banks as well. The question is, how do the banks and building societies respond in terms of attracting savings? Perhaps the most important factor for building societies in this is that they are required by law to be at least 50% funded through retail deposits and most, of course, are much higher than that. Most are in the 70% to 100% level. Will they have to put up savings rates in order to attract sufficient cash and retain sufficient cash? Of course, the flipside of that is whether that will have an impact on mortgage rates because the only other consequence is it has an impact on profits, which is therefore the building up of reserves in order to lend more in the following year. There is a whole equation to balance there.[375]

For her part, Dr Ros Altmann thought that the introduction of these bonds might "throw down a challenge to the industry, 'If you want to get some good pensioner money in you have to beat the pensioner bonds'".[376]

211. The Government's announcement that National Savings and Investments (NS&I) will offer 'pensioner bonds' at a market-leading rate represents something of a departure from NS&I's usual approach. NS&I is required to balance the funding needs of the Government, its customers and the wider financial services sector. Pensioner bonds have tilted this balance—in this case at least—in favour of customers and away from the Government and the financial services sector. The Government must provide clarity about the framework within which NS&I is now operating.

212. Since the Government has decided that it wants NS&I to give priority to customer interests, we recommend that NS&I consider once again offering index-linked savings certificates.

213. The increase of NS&I's Net Financing Target from £2 billion, plus or minus £2 billion, in 2013-14 to £13 billion, again plus or minus £2 billion, in 2014-15 could have a significant effect on NS&I's market share. The Government must ensure that this does not destabilise the wider savings market by crowding out private savings providers.

186   Finance Act 1995, Schedule 11 Personal Pensions: Income Withdrawals Back

187   HM Treasury, Removing the requirement to annuitise by age 75, July 2010 p 7, para 2.5 Back

188   HM Treasury, Removing the requirement to annuitise by age 75, July 2010, p 7, para 2.6 Back

189   HM Treasury, Removing the requirement to annuitise by age 75: A summary of the consultation responses

and the Government's response, December 2010, pp 7-14 Back

190   HM Treasury, Budget 2014, 19 March 2014, p44, para 1.164 Back

191   HC Deb (2013-14), 19 March 2014, col 793 Back

192   Q467 Back

193   Q471 Back

194   Q471 Back

195   ABI, Budget briefing, 24 March 2014 Back

196   Q467 Back

197   Q469 Back

198   www.gov.uk, News story: Pensions freedom for 400,000 hardworking people from today (HM Treasury), Published 27 March 2014 Back

199   HMRC, Budget changes - pension flexibility and changes to Finance Bill 2014, 9 April 2014 Back

200   Financial Conduct Authority, FG14/3 Guidance, Budget 2014 - Pension reforms: guidance for firms in the interim period, April 2014 Back

201   HM Treasury, Budget 2014, p42, para 1.157 Back

202   HM Treasury, Freedom and choice in pensions, pp 19-21 Back

203   HM Treasury, Freedom and choice in pensions, p31, para 4.12 Back

204   HM Treasury, Freedom and choice in pensions, pp30-31, para 4.11 Back

205   HM Treasury, Freedom and choice in pensions, p 34, para 5.6 Back

206   HM Treasury, Freedom and choice in pensions, p 34, para 5.12 Back

207   Q471 Back

208   Q452 Back

209   Q243 Back

210   Q300 Back

211   Q300 Back

212   Institute of Fiscal Studies, IFS Budget Analysis: introductory remarks, 20 March 2014, p 7 Back

213   Q279 Back

214   Q274 Back

215   Q299 Back

216   HM Government, Workplace pensions, accessed: 9 April 2014 Back

217   Q296 Back

218   Q69 Back

219   Q481 Back

220   Q412 Back

221   HM Government, Budget 2014: policy costings, p 66, para B.8 Back

222   Q204 Back

223   Institute of Fiscal Studies, IFS Budget Analysis: introductory remarks, 20 March 2014, p 3 Back

224   Q245 Back

225   Q410 Back

226   Q298 Back

227   Q475 Back

228   HC Deb (2013-14), 19 March 2014, col 792 Back

229   HC Deb (2013-14), 20 March 2014, col 951 Back

230   Department for Work and Pensions, Government confirms 2016 start for new flat rate State Pension, Accessed 9 April 2014 Back

231   Department for Work and Pensions, The single-tier pension: a simple foundation for saving, p 8, para 13 Back

232   Q294 Back

233   Q65 Back

234   Q66 Back

235   Q65 Back

236   Q210 Back

237   Q210 Back

238   Q317 Back

239   Department of Health, Landmark reform to help elderly with care costs, 11 February 2013, Accessed 9 April 2014 Back

240   Q274 Back

241   Q318 Back

242   Age UK, written evidence Back

243   Q211 Back

244   Q390 Back

245   HM Treasury, Freedom and choice in pensions, March 2014, para 2.1 Back

246   HM Treasury, Freedom and choice in pensions, March 2014, p 9, para 2.2 Back

247   Q272 Back

248   Q266 Back

249   Q318 Back

250   Institute of Fiscal Studies, Expectations and experience of retirement in Defined Contribution pensions: a study of older people in England, November 2012, p 11 Back

251   HM Treasury, Freedom and choice in pensions, p 23, para 3.19 Back

252   Q250 Back

253   Q311 Back

254   Q312 Back

255   Parliamentary Commission on Banking Standards, Changing banking for good, Volume I, p 19, para 23 Back

256   Financial Conduct Authority, Thematic review of annuities, February 2014, p 5 Back

257   Q471 Back

258   Association of British Insurers, The UK Annuity Market: Facts and Figures, February 2014 Back

259   Financial Conduct Authority, Thematic review of annuities, February 2014, p 9 Back

260   Q273 Back

261   Q474 Back

262   The Pension Advisory Service, Pension mis-selling, accessed: 10 April 2014 Back

263   Q473 Back

264   Q280 Back

265   Parliamentary Commission on Banking Standards, Changing banking for good, Volume I, p58, para 186 Back

266   Association of British Insurers, The UK Annuity Market: Facts and Figures, February 2014, p 1  Back

267   Pension Institute and National Association of Pension Funds, Treating DC scheme members fairly in retirement?, February 2012, p26  Back

268   HC Deb (2013-14), 19 March 2014, col 793 Back

269   Financial Times, Budget 2014: Insurers lose £3bn after pension fund shake-up, 19 March 2014 Back

270   HM Treasury, Freedom and choice in pensions, March 2014, p 3 Back

271   Financial Conduct Authority, Thematic review of annuities, p 20 Back

272   Q232 Back

273   Q269 Back

274   Q270 Back

275   Q297 Back

276   "Budget 2014: Pensions revolution casts pall on insurers", Financial Times, 20 March 2014  Back

277   "Budget 2014: Pensions shakeup could kill off annuity market, say analysts", The Guardian, 20 March 2014 Back

278   "L&G sees UK individual annuity market shrinking 75 percent", Reuters, 26 March 2014 Back

279   Q312 Back

280   Q246 Back

281   Q474 Back

282   Q274 Back

283   Q479 Back

284   Q479 Back

285   HM Treasury, Freedom and choice in pensions, p 20, para 3.14 Back

286   Q407 Back

287   Q246 Back

288   Q313 Back

289   HM Treasury, Freedom and choice in pensions, p 30, para 4.10 Back

290   HM Treasury, Freedom and choice in pensions, p 30, para 4.10 Back

291   Association of British Insurers, ABI sets out reforms to help boost retirement incomes for millions of savers, 10 March 2014 Back

292   Q423 Back

293   HM Treasury, Freedom and choice in pensions, March 2014, pp 30-31 Back

294   Q319 Back

295   Parliamentary Commission on Banking Standards, Changing banking for good, Volume II, June 2013, p 241, para 407 Back

296   HC Deb (2013-14), 19 March 2014, col 793 Back

297   HM Treasury, Freedom and choice in pensions, March 2014, p 30, para 4.11  Back

298   Q257 Back

299   Q281 Back

300   Q335 Back

301   Q267 Back

302   Q257 Back

303   Q264 Back

304   Q487 Back

305   Q283 Back

306   Q286 Back

307   HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, para 4.13 Back

308   Seventh Report of Session 2013-14, Money Advice Service, HC 457 Back

309   HM Treasury, Freedom and choice in pensions, Cm 8835, March 2014, p.3  Back

310   Q493 Back

311   Q491 Back

312   Q282 Back

313   Office for Budget Responsibility, Economic and fiscal outlook, March 2014, p 179, Table A.1 Back

314   Q422 Back

315   HC Deb (2013-14), 19 March 2014, col 793 Back

316   Q423 Back

317   PricewaterhouseCoopers, Budget 2014 - Annuity reform, key implications for the insurance industry, March 2014 Back

318   Q489; QQ340 Back

319   Q335; Q327 Back

320   Q482 Back

321   Department of Health, Factsheet 1: The Care Bill - General responsibilities of local authorities: Prevention, information and market-shaping, December 2013 Back

322   Q266 Back

323   Q284 Back

324   Q285 Back

325   Q283 Back

326   Q261 Back

327   Q335 Back

328   Q336 Back

329   Q492 Back

330   Q343 Back

331   Oral evidence taken on 4 February 2014, HC (2013-14) 1058, Q43 [John Griffith-Jones] Back

332   Oral evidence taken on 4 February 2014, HC (2013-14) 1058, Q59 [Martin Wheatley] Back

333   HM Treasury, Freedom and choice in pensions, March 2014, pp 33-36 Back

334   Money Advice Service, Transferring out of a defined benefit pension scheme, accessed 10 April 2014 Back

335   Q51 Back

336   Q67 Back

337   Q320  Back

338   Q305 Back

339   Q48 Back

340   Q48 Back

341   Q50 Back

342   Q206 Back

343   Q255 Back

344   "House prices continue to fall in February", The Guardian, 26 February 2009 Back

345   Nationwide house price index data - UK Series Back

346   Nationwide house price index data - UK Series Back

347   Nationwide house price index data and ONS consumer prices dataset, February 2014, series D7BT Back

348   Q405 Back

349   HM Treasury, Government welcomes first injection into Pensions Infrastructure Platform, 18 October 2012, accessed: 9 April 2014 Back

350   Q371 Back

351   Q48 Back

352   Q304 Back

353   Association of British Insurers, Briefing from the Association of British Insurers: Budget 2014, 24 March 2014, p 6 Back

354   Q411 Back

355   HM Treasury, Budget 2014, HC 1104, 19 March 2014, paras 1.167-1.169 Back

356   Q268 Back

357   Q357 Back

358   Q51 Back

359   Q53 Back

360   Q64 Back

361   Q352 Back

362   Q354 Back

363   HM Treasury, Budget 2014, HC 1104, 19 March 2014, para 1.173 Back

364   HM Treasury, Budget 2014, HC 1104, 19 March 2014, para 1.173 Back

365   HM Treasury, Budget 2014, HC 1104, 19 March 2014, para 1.173 Back

366   HM Treasury, Budget 2014, HC 1104, 19 March 2014, para C.11, p. 102 Back

367   National Savings and Investments, What we do, accessed 9 April 2014 Back

368   Oral evidence to the Treasury Committee, National Savings and Investments, HC (2013-14) 1131, 4 March 2014, Q8 Back

369   Q21 Back

370   Oral evidence to the Treasury Committee, National Savings and Investments, HC (2013-14) 1131, 4 March 2014, Q15 Back

371   Oral evidence to the Treasury Committee, National Savings and Investments, HC (2013-14) 1131, 4 March 2014, Q17 Back

372   HM Treasury, Budget 2014: policy costings, March 2014 Back

373   Q344 Back

374   Q345 Back

375   Q346 Back

376   Q287 Back

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Prepared 12 May 2014