Freedom and choice in pensions

Comments from ACCA to HM Treasury
July 2014

Summary

ACCA welcomes the moves to grant individuals control over their pensions funds and simplify the taxation of pension payments. However, the pace of change has been considerable and set against a background of reduced contribution limits and auto-enrolment ACCA is concerned that time is needed for changes to bed in and for the markets to respond to the revised regulatory landscape. Government should allow for a period of retrenchment and familiarisation, both for savers and scheme administrators.

The need for the pensions industry to react and innovate while digesting changes on several fronts suggests that a pause in the rush to reform would be timely. While changes for the better should of course be implemented as early as possible to maximise the number of individuals who can benefit, pensions are a long term concept and change should be undertaken at a considered pace.

The new proposals for access to savings are complemented by the subsequent proposals for Collective Defined Contribution, or Defined Ambition (“DA”) schemes alongside the existing Defined benefit (“DB”) and Defined Contribution (“DC”) arrangements. It seems widely acknowledged that the existing model of DC pension provision has not provided adequately for a significant number of pensioners, and some reform is desirable. The ability of DC fund members to Transfer to a DA scheme at any point, or even purchase a similar scheme on retirement, will represent a significant benefit for those who would otherwise be caught between the reduced investment returns on funds while in growth and increased cost of annuities against rising life expectancy.

General comments

Between the 1920s and the 1990s the UK developed a system of employer pension provision which was widely regarded as a model of benevolent corporate social responsibility. Individuals who had remained in steady employment could look forward to a guaranteed income on retirement. Stakeholders on all sides recognised both the value and the associated costs of the model.

However, since then a number of fundamental changes have significantly changed the landscape of employer pension provision. Changes to the tax and regulatory environment have increased the cost of defined benefit pension provision to a point where management, under the pressure of increasingly short term financial return driven shareholder demands, often found schemes to be unsustainable. In addition, recognising the bewildering variety of schemes and tax rules which had sprung up by 2005, a sweeping reform and simplification was promised.

Since A-Day, successive governments have nevertheless been unable to resist continued changes to the pension regime, most of which, especially when combined with transitional provisions around A-Day, have increased complication in the system and reduced the tax incentives provided.

The current proposals do represent a genuine simplification in the system for the vast majority of schemes and pensioners, although there will inevitably be situations where those benefits may be limited or even counteracted by other factors. In addition we question whether a part of the motivation for the proposed reforms is the billions of pounds in additional tax revenues which are being anticipated under the new regime. We consider the reforms should be designed to be tax neutral.

A further issue is that the proposals only address one side of pension provision; the drawdown/utilisation of funds. Taxation of extraction has never been as complex or controversial as the reliefs afforded on contributions into funds in the first place. The prospect of more beneficial treatment of funds in retirement will be an attraction only so long as individuals genuinely believe that those benefits will still be available and worthwhile in retirement. The non-stop tweaking with rules around contributions into schemes will inevitably dent individuals’ confidence that politicians can be trusted not to meddle with the rules again in the future.

ACCA supports the aims of choice and simplicity in allowing individuals access to the funds invested in their pensions. But, as has been an underlying theme of the many responses that ACCA has had to make on changes to pension provision over the last few years, pensions are a long term investment and should be dealt with accordingly by policy makers. While these proposals do meet with a welcome from ACCA, they come yet again with the plea that government resist the temptation to shift the goalposts again in future for pension savers and the schemes that administer those funds.

Historically pension fund managers would have planned in terms of 60 or 80 year horizons. The importance of such a long term view has not diminished, but the ability of even the most farsighted and prescient investor to confidently plan over such timescales is inevitably compromised by regular policy changes imposed through regulation.

Specific comments

A new tax framework for retirement (Chapter 3)

1. Should a statutory override be put in place to ensure that pension scheme rules do not prevent individuals from taking advantage of increased flexibility?

There is a delicate balance to be struck between promoting choice and diversity, and controlling risk to pensioners. However, provided there is a right to transfer to another qualifying pension scheme then the risk to members will be significantly reduced. It is in any event difficult to see how a further statutory provision would interact successfully with the already complex interaction of obligations on pension trustees where a transfer out might reduce a notional deficit, to the benefit of remaining members.

2. How could the government design the new system such that it enables innovation in the retirement income market?

The recently announced proposals to legislate for collective pension schemes based upon a “defined ambition” model can be expected to encourage diversity in fund design and structure. Perhaps the most effective way that the government could ensure that the market is able to develop would be to design the new system once, and then stop. Continued revisions to regulation will stifle any interest that the market may have in innovation, since there will be no perception of any guarantee that conditions will remain favourable to new ideas.

3. Do you agree that the age at which private pension wealth can be accessed should rise alongside the State Pension age?

The primary function of a pension was originally to provide for an income for those no longer able to earn a regular income. As society has grown and changed, and the welfare state introduced a safety net for all UK citizens, so the role and relevance of private pension provision may have changed in public perception. However, the key feature of a pension is the tax relief offered by government. Pensions are uniquely advantaged for tax purposes, with employees and employers benefiting from tax relief on contributions to schemes.

Any changes to the regime which reflect the role of the private pension as a means to accelerate an active retirement, rather than simply reduce the burden on the state of an individual’s twilight years, must be balanced against the preferential tax treatment of the investment. While the principle of allowing savers free choice to access their investment is key, if individuals have managed to save enough that (based on sound independent advice) they can support themselves for the rest of their expected lifespan then in the light of shifting demographic patterns the government should be encouraging them to retire and facilitate workforce regeneration. However, as life expectancies increase and individuals remain active later into life, it is important that pension saving retains its character as the provision of tax advantaged saving for a specific and clearly defined phase in life. Accordingly it seems appropriate that the age limits for private pensions should move in step with the age limits for the State pension, and for the same reasons.

4. Should the change in the minimum pension age be applied to all pension schemes which qualify for tax relief?

Yes. All non-state pension schemes should be treated equally, and all employer or private schemes should allow for the taking of benefits from as early as is reasonable against the background of wider demographic changes.

5. Should the minimum pension age be increased further, for example so that it is five years below State Pension age?

No. The additional complication arising from further change to the pensions regime is not justified. Moreover, the government’s own statistics indicate that the period for which individuals can expect to be reliant on pensions income has nearly doubled since  the introduction of the full state pension in 1948; halving the period in which individuals can benefit from their own saving would reduce the incentive to retire earlier and free up employment slots in the workforce.

There is of course a concern that individuals might struggle to effectively manage their finances once able to access their personal pension pot, and reducing from 10 years to 5 the period in which they rely entirely upon their own savings would reduce the likelihood of funds being totally dissipated before the state pension is available as a safety net. However, the proportion of life which individuals now expect to spend “in retirement”, and their expectations of it, have also changed radically.

Supporting choice (Chapter 4)

6. Is the prescription of standards enough to ensure the impartiality of guidance delivered by the pension provider? Should pension providers be required to outsource delivery of independent guidance to a trusted third party?

Independence will be crucial in ensuring that individuals receive the best value for money from whatever draw down options they choose for their pension. One of the key criticisms levelled at the regime for annuities is that a lack of information and appreciation of the options by pensioners has resulted in reduced incomes for the majority of those who purchase an annuity.

However, the impartiality of the guidance will depend more upon the quality of advisers and their training than it will upon any prescription as to the delivery mechanism. Broadening the base of advice providers is more likely to promote competition and higher standards than would be the creation of a separate over-regulated niche.

7. Should there be any difference between the requirements to offer guidance placed on contract-based pension providers and trust-based pension schemes?

No. The guidance exists for the benefit of the employees, not the convenience of the provider. While it may well be the case that the obligation to provide for fully paid impartial advice imposes a proportionally greater burden on trustees than it will commercial scheme providers, this is an unfortunate but unavoidable consequence of the historic choice of pension form.

8. What more can be done to ensure that guidance is available at key decision points during retirement?

A general emphasis on the importance of financial literacy will pay dividends in fields far beyond just pension choices. Pensions planning should be a long term operation, and the government should invest in a similarly long term approach to financial education. In addition to consideration of resources for schools and colleges to prepare students for independent life, the government should bear in mind changes in the way that guidance in information generally is consumed.

Consumers are increasingly using the internet to research their options when making important purchases, and there is no reason to believe that an open market for retirement options would be any different. The provision of clearly written and impartial government advice, hosted on official webpages but accessible by and promoted to all other interested parties would be a useful element in the wider landscape of guidance. Such advice would of course need to highlight the availability and importance of one-to-one advice under the new regime.

Defined benefit schemes (Chapter 5)

9. Should the government continue to allow private sector defined benefit to defined contribution transfers and if so, in which circumstances?

In the light of the proposals for collective defined contribution, or “defined ambition” (“DA”) schemes, it would appear inappropriate to restrict the freedom of individuals and schemes to transfer out of existing defined benefit schemes.

The existing rump of defined benefit schemes are very often a significant economic drag upon the companies which have to support them. Allowing members to transfer from an underfunded company DB scheme to a DA scheme could have benefits both for the individual and the company, subject of course to funding for the transfer being available.

There must be clear guidelines as to the quality and nature of guidance given to members given the potential risks to the individual of any such transfer out, but such efforts are in any event already under way in response to the phenomenon of “pensions liberation”.

10. How should the government assess the risks associated with allowing private sector defined benefit schemes to transfer to defined contribution under the proposed tax system?

It seems implicit in the wider scheme of changes to pension provision and access to funds that the government is seeking to prioritise the interests of the individual in retirement, rather than the financial or administrative interests of others involved in the market. Accordingly, if it is the best interests of the individual scheme members that are incentivising action then this should be the perspective from which the “risks” are assessed.

For many individuals, a defined benefit scheme may not offer the best outcome – for example, a single individual in poor health, who may very well be in a position where even their underfunded share of a scheme may provide a better return if converted into an annuity or flexible drawdown model than it would if held within the rigid structure of a DB model.

The assessment of risk should be made in the light of members’ needs in retirement, and whether denying DB scheme members the choice and freedoms available to DC scheme members is an appropriate option in the light of the policy aim and other factors.