Pension freedom in retirement?

The 2019 party manifestos confirmed cross-party support for key areas of pension policy. The parties continued to commit to pensioner benefits and uprating the State Pension by the ‘triple lock’. There was also support for the policy of auto-enrolment in workplace pensions and the principle of a ‘pensions dashboard’. This would allow people to see all their pensions savings in one place.

There are still challenges to ensuring that people have adequate income through retirement. Despite auto-enrolment, an estimated 12 million individuals are undersaving. Half of them are only undersaving mildly, but 1.5 million are undersaving substantially.

More people are using defined contribution pension plans

As Chart 1 shows, the pensions landscape is changing. Auto-enrolment has led to a rise in the number of employees saving in defined contribution (DC) pension plans. The numbers are up from 1 million in 2012 to 10 million in 2018. There are now more people enrolled in DC schemes than in defined benefit (DB) schemes

In a DC pension scheme the income available at retirement will depend on many factors. These include contributions made, any charges applied, the way the fund is invested, and decisions made at retirement. In April 2015, the Coalition Government introduced a ‘pension freedoms’ policy. This gave people aged 55 and over more choice about when and how to draw their DC pension savings. Previously, three quarters of people had had to buy an annuity, which provides a guaranteed income. Now, however, they can make flexible lump sum withdrawals.

The challenges with the pension freedoms policy

The Coalition Government had hoped that the reforms would stimulate innovation and competition. However, there were concerns that the reforms made individuals responsible for decisions they were often ill-equipped to make. These decisions would have a significant impact on their income in retirement and whether their savings would last into later old age.

One concern was an increased risk that people might draw too much of their savings prematurely and face hardship in later retirement. So far, there is little evidence of this. While over half of pension pots accessed since 2015 have been fully withdrawn, this was most common with the smallest pension pots. These pots usually complement other sources of pension income. However, this may change as people become more reliant on larger DC pots.

Instead, evidence from the first four years has focused concern on the nature of the decisions made (or not made) at retirement by the increasing numbers entering pension drawdown arrangements.

As shown in Chart 2, pots accessed via drawdown accounted for £28 billion (70%) of the £40 billion-worth of pension pots first accessed in 2018/19.

Increasing numbers of those accessing drawdown are doing so without advice. At this point, they face a range of complex decisions such as which provider to use, where to invest their remaining pot, and how quickly to draw down. These decisions are made within significant uncertainties, not least how long they can expect to live. The Financial Conduct Authority found that many struggle with these decisions and end up in investments that may not be right for them, or putting their pension pot into cash. Its plans to help with this include requiring schemes to provide ‘investment pathways’, covering a small number of typical uses for a pension pot. Whether its plans go far enough remains to be seen. The issues will need to be kept under active review in the next Parliament.

Other key issues in pension policy

Some of the other issues debated but not resolved in the last Parliament include:

• How to take forward plans for pensions dashboards and collective benefits, included in the Pension Schemes Bill presented to Parliament shortly before the election
• Plans to allow employers who cannot afford to fully insure their pension promises to pass on their liabilities without compromising benefits
• When and how auto-enrolment contribution rates should increase
• Plans to improve the returns from auto-enrolment for low earners, including those who miss out on tax relief
• How to better protect people from scams
• How to ensure people get the best value from their savings, whether through better advice and guidance or the design of pension products
• How to ensure people considering transferring out of a fixed pension promise into a flexible arrangement get the right advice
• Whether the timetable for future increases in the State Pension age should change.

One option, to which politicians return from time to time, could be a successor Pensions Commission to review the landscape, now much changed since the last one reported in 2005.

Further reading

• Pension flexibilities: the freedom and choice reforms, House of Commons Library
• Automatic enrolment: current issues, House of Commons Library