Pension flexibilities: the ‘freedom and choice’ reforms

Individuals with defined contribution (DC) pensions build up a pension fund using contributions, investment returns and tax relief. Before 6 April 2015, most people used their DC pension funds to purchase an annuity. This was strongly encouraged by the pension tax legislation in force at the time, which authorised lump sum or flexible payments in limited circumstances.

In Budget 2014 the Coalition Government announced that from 6 April 2015 people aged 55 and over would be able to make withdrawals from their DC pension pot “how they want, subject to their marginal rate of income tax in that year.” Legislation for this was in the Taxation of Pensions Act 2014. To help people navigate the wider range of options, a guidance service – Pension Wise – was established – see Library Briefing Paper SN 7042.

Following press reports of perceived difficulties, the Government launched a consultation in July 2015 on whether individuals were able to access the new pension flexibilities easily and at a reasonable cost. An update from the FCA said that the overall majority of consumers had been able to do so, with some exceptions (PN15-28). In February 2016, the Government announced proposals for making the transfer process smoother and more efficient. It placed a duty on the FCA to impose a cap on early exit charges (Bank of England and Financial Services Act 2016, s35) and enabled this to be implemented in occupational schemes in Part 2 of Pension Schemes Act 2017.

The Work and Pensions Committee published a report on pensions freedoms on 5 April 2018. It found that there was “little evidence that savers were frivolously squandering their life savings” but that this did not mean that people were making well-informed pension freedom decisions. It proposed a two-pronged approach:

• Protecting savers by requiring providers to offer a “default decumulation pathway suitable for their core customer group” and allowing NEST to offer decumulation products, including a default drawdown pathway, from April 2019.
• Empowering savers to choose by requiring providers to offer single page pension passports and provide necessary information to the pensions dashboard, which should be hosted by the new single financial guidance body, funded an industry levy and in place by April 2019. (HC 917, April 2018, summary).

In its June 2018 Retirement Outcomes Review (RoR) report, the FCA found that:

• there are weak competitive pressures and low levels of switching. Most consumers choose the ‘path of least resistance’, accepting drawdown from their current pension provider without shopping around
• one in three consumers who have gone into drawdown recently are unaware of where their money was invested
• some providers were ‘defaulting’ consumers into cash or cash-like assets, but holding cash is highly unlikely to be suited for someone planning to draw down their pot over a longer period.

Following this, the FCA consulted on proposals to require providers to offer customers entering non-advised drawdown ‘investment pathways’ i.e. readymade drawdown investment solutions, appropriate to standardised objectives. It also proposed measures to: ensure that consumers entering drawdown only invested mainly in cash if they had taken an active decision to do so and; to measures improve transparency of charges (CP 18/17, PS 19/01; CP 19/5; PS 19/21). The FCA also recommended that the Government consider ‘decoupling’ tax-free cash, because many consumers focused on that at the expense of other pensions decisions at that point (ROR, para 1.38).

In a report published in July 2018, the Treasury Select Committee expressed concern that “the level and quality of consumer protection and default investment pathways associated with the pension freedoms do not appear sufficient at present.” It recommended that the Government work actively with the FCA to identify opportunities to enhance both. It also said the Government should keep under review whether individuals started to purchase annuities in later retirement to protect against longevity risk. If not, it should consider intervening.

Other reading:

The plans for pensions dashboards are discussed in CBP 8407 (May 2019).

The decision not to allow annuity holders to sell their income stream to a third party is discussed in CBP-07077 Secondary annuities market (August 2018).