The pension freedoms worked wonders – but not everyone was a winner
I was pensions minister when George Osborne’s 2014 Budget sent shockwaves through the retirement industry. Before the pension freedom changes, most people who retired with a “pot of money” style pension had just one option. They had to hand it over to an insurance company in return for an income for life known as an “annuity”.
Those with tiny pots could cash them out, and those with large pots had limited flexibility, but for most people there was only one destination.
The problem was that you were getting very little income for your pension cash.
Following the financial crash, interest rates and annuity rates plunged. In early 2008, someone with a £100,000 pension pot at retirement would have been offered around £7,700 per year by an insurance company. By April 2015, the annuity on offer had slumped to around £5,500.
The system was also very inflexible. Whilst there’s nothing wrong with an income for life if that’s what you want, everyone is different.
For example, you might be part of a couple with two good state pensions and a company pension as well, so extra secure income might not be a priority.
The revolution in the 2014 Budget was, to quote the Chancellor back then, that “no-one will have to buy annuity”.
Instead, people could flex their pension savings. They could go on investing the money, taking chunks out as and when they wished. Or they could take the whole lot out, enjoying a tax free lump sum and paying tax on the rest. These changes have been hugely popular.
Annuity sales slumped after the announcement. In 2013, around 350,000 annuities were sold by insurance companies but this fell by more than 80pc by 2015.
Once people were not forced to buy an annuity, most did not do so. Instead, people enjoyed the freedom to use their pension as they wished. By far the most common option has been to cash the pot out in full.
Official figures show that roughly 50-60pc of all pots accessed are cashed out. Around one in five people have used the money from a pension pot to pay off debts, and around two in five people have saved or invested some of the money.
Around one in 10 people have given money to family. At the other end of the scale, nearly half said they had used the money for a large purchase such as home improvements or buying a car, and around two in five people spent some of the money on a holiday.
Although spending your pension on a holiday or a new car might sound reckless, the vast majority of these full encashments are for small sums of money – mostly under £10,000.
Whilst £10,000 can make a nice contribution to a special holiday or to help a child with a house deposit, it was never going to generate a meaningful regular income when spread through retirement.
If people get to enjoy their small pension pots at a time and in a way that suits them, why should we object?
The one black spot looking back relates to people who were encouraged to give up their “final salary” pensions in exchange for pot of money pensions, specifically to take advantage of these new flexibilities.
This led to something of a feeding frenzy amongst certain sections of the financial advice market. Whilst some people transferred out based on expert and impartial advice and are happy with the outcome, many thousands received poor advice, often motivated by high fees, and would have done better to remain where they were.
Battles over compensation for this poor advice continue to this day.
There are two big areas of unfinished business. The first relates to advice and guidance at retirement. The Government set up a free guidance service called Pension Wise which gives people factual information about their options. But it cannot tell them what they should do.
As more people need to think about carrying on investing rather than cashing out, this “advice gap” will need to be addressed.
The second outstanding issue is what happens in later retirement. How capable will we all be of managing an investment pot into our eighties and nineties?
When we have no idea if our pot has to last for another five years or another 20, this makes it increasingly difficult to get it right. Ironically, we may see the return of later-life annuities as part of the solution to managing our money in later retirement.
Although Pension Freedoms were controversial, there are few people now saying they should be reversed.
Had the policy not been introduced, hundreds of thousands more people would have been locked into very poor annuities for the rest of their life. Instead, people can now shape their retirement finances in the way that is right for them, and even – whisper it quietly – enjoying their money.
If that is the main criticism of pension freedoms, then I plead guilty.
Steve Webb is a partner at consultants LCP and was Pensions Minister 2010-15.
