It’s now two and a half years since over-55s were given much greater control over their retirement savings. Adam Burn, Corporate Pensions Technical Manager explores what we’ve learned so far.
The introduction of pensions freedom and choice reforms in 2015 has driven a marked change in how employees relate to their retirement savings. With the opportunity to access any combination of annuity purchase, drawdown and cash, those aged over 55 now have more options than ever before about how to use their money.
A positive outcome from this is that employees have become more engaged with their pension. As the choices on offer and the opportunities they represent grow, so has older workers’ interest in their savings pots.
But the changes have also introduced new risks. Before the reforms were announced, in Q1 2014, 92%* of individuals accessing their pension for the first time purchased annuities. The remaining 8% used some form of drawdown. That small proportion of retirees who opted for drawdown were typically financially aware and would, in many cases, have had access to an adviser who would be able to guide them when making their decisions.
Since 2015, the percentage of over-55s who have moved into drawdown has surged. According to the Financial Conduct Authority (FCA), twice as many pots are now being moved into drawdown as are being used to buy annuities*, and annuity sales have plunged 21% in the last year**. Employees are being seduced by the idea of managing their own money – and while that has the positive effect of making people more engaged with their pension, many are embarking on this major decision without taking any advice.
According to recent figures from the FCA, 30% of those who have moved into drawdown since 2015 did not take advice. That compares to just 5% of those who opted for drawdown prior to the 2015 reforms *. However, there are relatively few employees who are genuinely in a position to manage drawdown decisions effectively, taking account of all the nuances and tax considerations that relate to this type of product. There is also ongoing legislative change to consider, such as the forthcoming reduction in the Money Purchase Annual Allowance, which will restrict the amount of money individuals can pay into a pension once they have started to withdraw funds.
The rate of change has left regulators and the pensions industry struggling to keep up. The new culture of ‘DIY drawdown’ could cause problems for increasing numbers of employees who subsequently struggle with the decisions they have made and may need to turn to a professional for support in rectifying their finances.
Another marked change in behaviour has been the withdrawal of cash lump sums from the scheme. This has traditionally been known as the Pensions Commencement Lump Sum (PCLS) – but now doesn’t have to herald any kind of pension commencement. Instead we are seeing employees reach the age of 55 and withdrawing cash from their pension pots, but not actually choosing to retire or take regular income. To date, 54% of defined contribution (DC) pension pots have been withdrawn in full as cash, and although the numbers who are choosing to do this are falling, it is still the most common method used by consumers to access small pension pots**. Paying off the mortgage, buying a new or additional property, or simply passing money down through the generations are some of the key ways in which that cash is being used.
The separation of cash lump sum withdrawals from actual retirement has implications for employers as well. Rather than waiting until full retirement to fulfil ambitions such as being mortgage-free, employees are achieving that earlier, and then remaining in work. That is helping to drive an older workforce, where individuals access a portion of their savings and then remain in employment, either full-time, or in a more flexible capacity. Managing younger workers’ career aspirations and reconsidering job design to accommodate more varied working patterns are just two of the knock-on effects for employers.
But it’s still early days for freedom and choice, and while we see trends starting to emerge, there still isn’t a clear picture in place. Two years after the legislation came into force, we don’t have enough data yet to truly benchmark behaviour effectively, or to make realistic predictions for the future. However, the patterns we do see starting to form have implications for the way in which employers and the advice industry support individuals with their retirement choices, and for workforce planning.
As an industry and in society we need to constantly review the products and advice structures on offer. Regulators will also need to work hard to remain ahead of challenges and abuses, to make sure they can protect consumers – particularly those who remain keen to make their own, unadvised choices.
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