4 Pension reforms and savings
Increasing pension flexibility
PAST REFORMS
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]
IMMEDIATE CHANGES
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]
PENSION REFORMS FROM APRIL 2015
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
AUTO-ENROLMENT
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]
THE UNCERTAIN IMPACT OF THE REFORMS
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.
FALLING BACK ON TO THE WELFARE STATE
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 financesfor
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.
LONGEVITY RISK
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.
FINANCIAL INNOVATION
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 potsthe 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 vehiclecall it draw-down, for the sake of no
other label being available at the momentwhich 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 positivethe 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.
GUIDANCE, ADVICE AND CONSUMER PROTECTION
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.
WHEN SHOULD GUIDANCE BE MADE AVAILABLE?
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.
DEVELOPING THE GUIDANCE GUARANTEE
AND THE MONEY ADVICE SERVICE
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.
WHO SHOULD DELIVER THE GUIDANCE
GUARANTEE?
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 membersthe insurance
companieswould 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.
WHO WILL PAY FOR THE GUIDANCE GUARANTEE?
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.
INTERACTION WITH EXISTING AND PROPOSED
GOVERNMENT SPONSORED GUIDANCE
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.
PRINCIPLES FOR THE 'GUIDANCE GUARANTEE'
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
DEFINED BENEFIT SCHEMES
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]
CHANGES IN CONSUMPTION AND ASSET
ALLOCATION
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.
FUTURE INFRASTRUCTURE INVESTMENT
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 disappearpeople currently have a
lot of money invested in annuitiesbut 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 freenever been taxed on the way in, not
taxed when it is there, not taxed on the way outhas 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 customersoffering them a
fair rate; taxpayerswith our remit to raise cost-effective
finance for government; and the wider financial services sectorsupporting
stability.[367]
We took evidence from the Chief Executive
of NS&I, Jane Platt, and its Partnership Director, Steve Owen,
on 4 Marchtwo 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 andto a lesser
extentthe 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 balancein
this case at leastin 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.
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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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