The Government’s decision to “liberalise” pensions is in serious danger of removing choice rather than enhancing it. Why?
This article from the New York Times helps to explain the problem. Given a choice between a “defined benefit” pension scheme and a defined contribution scheme most of us would prefer the former. But the decision to buy an annuity is complex and scary and involves making a gamble. We feel we are likely to be ripped off (and often we are). Psychologically we’re not happy with the idea of deciding how long we are likely to live. So we make bad choices.
As John McTernan has pointed out, pensions are a collective solution that works. It is in all our interests that everyone has a pension so that they can afford to live as long as they live. Apparently the pensions minister is happy for people to use their pension pot to buy a Lamborghini because the worst case scenario is that they will end up having to live on a state pension. But actually this ignores the huge concerns over the rising cost of care. As Andrew Dilnot, Chair of the Government’s Commission on Funding of Care and Support said in launching the Commission’s report:
The issue of funding for adult social care has been ignored for too long. We should be celebrating the fact we are living longer and that younger people with disabilities are leading more independent lives than ever before. But instead we talk about the ‘burden of ageing’ and individuals are living in fear, worrying about meeting their care costs.
The current system is confusing, unfair and unsustainable. People can’t protect themselves against the risk of very high care costs and risk losing all their assets, including their house. This problem will only get worse if left as it is, with the most vulnerable in our society being the ones to suffer.
As well as the problem for individuals, the cost to Government of supporting people whose savings have run out is considerable. So although there is a windfall to the Treasury of moving away from annuities (take your lump sum now, and the tax on it gets paid now too), this is only bringing forward future income rather than creating new income – and in the long term these changes will cost welfare budgets more too. Government does have a financial interest in ensuring that people are able to provide for their old age in a way which means that they don’t have to fall back on the state as well as being in a position to ensure we are all able to exercise meaningful choices right to the end. As the Institute of Fiscal Studies has pointed out, these changes are likely to destroy the market in annuities – so that option will no longer make sense.
There is a win-win alternative: instead of abolishing the requirement to buy an annuity because the annuity market doesn’t work very well, why not offer a fall-back option for people of a government-backed annuity? Require pension providers to inform their clients of the government option: a statement along the lines of “stick with us and you can have £1,000 a month or transfer to the Government scheme and you can receive £1,200 a month” would put an onus on providers to sharpen their pencils or lose business. Of course other options may make sense for some people (paying off debt will always make sense). But the starting point should be for anyone wanting to explore other options to take independent financial advice with very clear recommendations recorded and retaining the tax benefits should depend on this advice being followed – and that the solution provides a long-term income stream.