When the pension freedoms were announced in the 2014 Budget, it seemed everyone was taken by surprise. Lately, however, I have found myself wondering how long they had been in the making.
In 2014, the only way people could take as much out of their pension as they liked (small pots and trivial commutation aside) was flexible drawdown. It was only available to individuals who could prove they had enough guaranteed income from other sources. They had no need for the drawdown fund to last their whole retirement.
Was flexible drawdown a way of trying out the pension freedoms with a relatively safe group of test subjects? Data from the first couple of years of flexible drawdown would have shown most people were not exhausting their pensions in one go, thus disproving the original fear.
Less than three years after flexible drawdown was introduced for a small group of individuals, it was effectively extended to everyone.
Have things gone to plan since then? It depends on who you talk to. In their first year, the pension freedoms gave the government an income tax take five times higher than initially projected.
This was probably good news for the government. But it suggests people took a greater amount out of their pensions than expected. It seems the behaviour of the few in flexible drawdown was not reflective of the behaviour of the population at large.
This probably should not have come as a surprise. Generally speaking, investors who were eligible for flexible drawdown were more likely to be financially savvy, more likely to have an adviser, and more likely to understand and trust pensions. Also, because they had guaranteed income from other sources, the consequences of them doing something less than sensible with their drawdown pension were less severe.
Wrong end of the stick
From the point of view of a regulator, the pension freedoms have presented quite a headache. The data still shows the majority of people are not draining their pensions in one go.
Most of the exhausted pots are very small and likely to belong to people who have other pensions or retirement provisions elsewhere. However, the numbers are still enough to keep regulators and professional bodies concerned. They continue to look for new ways to protect consumers.
One idea is to introduce default investment solutions for drawdown. This was discussed in the retirement outcomes review (ROR) interim report and reiterated recently in the work and pensions committee’s pension freedoms report.
Actually, for completeness, I should say the ROR interim report discussed default investment solutions. The work and pensions committee’s report simply said ‘default pathways’, leaving us to assume it means the same thing.
Default solutions are problematic for a few reasons. First, as people were quick to point out when the report was released, the report still exclusively treats drawdown as a product. It ignores the fact it is often a feature of a product.
As such, no one has yet suggested how this idea would work for products such as Sipps, where the provider simply offers the pension wrapper and does not offer investment solutions. The idea of providing default investments almost seems to go against the idea of the product.
The work and pensions committee’s argument is auto-enrolment has successfully used people’s inertia to transform the accumulation stage of pension saving. Therefore, it claims the same thought process could be applied to the decumulation phase.
But there is a difference between using people’s inertia to their advantage, and protecting them against it. More importantly, the committee’s idea is not simply the decumulation version of auto-enrolment.
Greater choice needed
Auto-enrolment has helped millions of people into pension saving. But its rules and conditions do not apply to all pensions that allow accumulation.
Providers can choose to only offer products that cater for other groups of consumers, such as those who want to actively engage with pension saving and investment.
The work and pensions committee’s recommendation, however, is to make all drawdown providers offer default solutions. There is no real acknowledgement this may not be suitable for all providers or consumers. It does not quite seem to fit with the idea of pension freedoms and choice.
Jessica List is pension technical manager at Curtis Banks Group.