The pension freedoms revolution

The pension freedoms revolution

An economist once said: “He who lives by the crystal ball soon learns to eat ground glass.” And, in an ideal world, crystal ball gazing is best left to astrologists and their followers. However, in a world that is far from ideal, we are compelled to make informed forecasts – particularly in the realm of pensions.

A reader asked me a question recently which caught me unaware. He asked what would happen from a regulatory point of view when hundreds of thousands of people with little or no investment experience start retiring every year on defined contribution only pensions and move into drawdown?

One short answer is…nothing. Pensions freedoms mean exactly that - liberty to do what one wishes with one’s own money. Government minister after government minister told the UK electorate in 2014 and 2015 that it’s ‘your money to do with as you please’. And certainly, if we have a long period of strong investment returns and low levels of volatility there’s every chance that the status quo could hold.

With freedom comes responsibility

But there are two reasons to suspect that change is coming - even if asset class returns are good.

The first is that the Financial Conduct Authority (FCA) has already indicated its anxieties about the world since pensions freedoms came into full effect. In particular, they worry about the extent to which individuals with no historical experience of investing are passing into drawdown (the passive tense is deliberate) without any conception of the risks and rewards involved. A recent survey found at least one third of those entering drawdown now had little or no investment experience. The FCA calls this “zero income drawdown” because it provisionally concludes that drawdown for this group is simply viewed as a kind of bank account - attractive because it facilitates the withdrawal of flexible slugs of tax free cash. Or, to put it another way, pensions freedoms are encouraging savers to become investors, by the back door and without any measurement of their risk appetite.

In this context, the second reason to expect regulatory movement - the sheer size of the “advice gap” - becomes an imperative. The Financial Advice Market Review is best viewed as a dress rehearsal for the real thing. At the moment, we remain in the midst of income drawdown’s phoney war. As long as the vast majority of money in drawdown belongs to individuals with defined benefit pensions in payment - and lots of other wealth assets too – there is no real sense of urgency in closing the advice gap. When the skirmishes end, however, and the field is dominated by hundreds of thousands of defined contribution only retirees who have spent their whole working lives in the default pension investment fund and in cash more widely, things change.

A decision for the government

But what kind of change? This depends on whether the government doubles down on pensions freedoms or not. If the government determines that advice must be given to these new retirees then the definition of guidance will be expanded until it enables a recommendation of some kind with advisers paid directly by the government to deliver this service, using technology to keep the cost down. Or the banks will be green-lighted by Government to re-enter the advice market.

If, on the other hand, the government decides that pensions freedoms take rights too far at the expense of responsibilities, it is likely that policy would return to the position in which it sat between 2014 and 2015 – namely, that individuals would need a guaranteed income of circa £20,000 and would have liberty to do whatever they wished with the rest.

Predicting the future is for astrologers – and at the moment, it’s anyone’s guess which path the government will follow. But revolutions play out over decades - not days - and the new world of pensions freedoms is indeed revolutionary.