Emma Wall: Hello, and welcome to this Ask the Expert, Pensions Special. I'm Emma Wall, and here with me today is Tom McPhail, Head of Pensions Research for Hargreaves Lansdown. Hello Tom?
Tom McPhail: Hi.
Wall: So the big thing on the agenda right now is what does the pensions' market look like post George Osborne's Budget?
McPhail: Okay. So the Budget announcement in March was absolutely a seismic event. It was a game changing moment when the Chancellor, a good old-fashioned libertarian, small ‘c’ conservatism, said 'look, it's your money, you can have it back'; which is fine as far as it goes and I think it was a political masterstroke, but has now opened up myriad challenges in how we deal with that and how we make sure people get good outcomes from all of that.
So there's a huge amount of work going on behind the scenes to try and deal with that. There was no consultation. There was no warning. Nobody knew it was going to happen, which makes it quite exciting, but also now makes it extremely challenging to deal with because we're having to do this from a standing start. And the announcement said, 'look, within a week, you can take advantage of these new freedoms'; and the entire industry sort of went, 'well, hang on, we're not ready for this'. But we have to deal with it, and we've already got people ringing up, saying, 'well, can I have my money now please?', and there are some problems with all of that. So we're just trying to work through it all right now.
Wall: It's had, as you say, a big impact on the pensions industry. I mean, almost immediately, the share prices for a lot of those big annuity providers fell to the ground because, of course, no one has to buy an annuity anymore. And there was this sort of silver lining, I suppose, of opportunity business-wise for these pension providers that there has to be a bit of advice before you can take it, and perhaps you can tell us a bit more about that?
McPhail: So I mean, it was particularly the monoline insurers, the ones who are hugely dependent on the annuity market. Those are the ones who saw their share price halve on Budget Day. But you're right. There are controls, and then, look, I think reports of the demise of the annuity have been somewhat exaggerated. There is still undoubtedly a market for annuities. We've already seen from research with Hargreaves Lansdown's clients that a lot of people still want certainty, they want security, 'I'll give you the money, you give me a guaranteed income for life'. Now, for a lot of people, that's still a very attractive proposition.
So that will continue. I suspect we're going to see people annuitizing a bit later. But we're going to see more activity around these sort of asset-backed income withdrawal arrangements, and so that's all developing. And you're right. They've flagged up, everybody is going to get guidance. So the Government said, everybody has a right to get some guidance at the point of retirement.
Wall: For free?
McPhail: For free? No, nothing is free. Not even the NHS. So, free at the point of delivery and so, the pensions industry behind-the-scenes is going to have to pay for this, and so frenetic activity going on at the moment to work out to how this is going to work, how it's going to be policed, controlled; who is going to deliver it; how people are going to access it? Face-to-face as well in theory, everybody with a defined contribution pension has a right to sit down in front of somebody and have their options explained to them.
Wall: Which normally costs a couple of hundred pounds an hour.
McPhail: At least. And so this guidance is probably going to be quite superficial. Certainly to start with, it may evolve and may become more sophisticated, but to start with, it's really just going to be briefly walking you through your options, highlighting pitfalls, talking to you about the kind of stuff you need to know before you can make a decision. And over time, over the next few years, we may see it evolve into something more sophisticated, but it will be delivered by next April and it will therefore probably within this very tight timeframe be quite simple to start with.
Wall: You say that we have a year from the first announcement for the pensions industry to get itself in gear. That is an immovable deadline, isn't it?
McPhail: Absolutely. Politically, it can't move. It's a month before the elections. So the political cost to George Osborne of having to rather sheepishly announce somewhere near the time that we're not quite ready for it, it's just not an option. And politically the Budget was a master stroke. It was extremely popular, made pensions popular which in my book is a good thing. So he can't back down on that one. So and that's where I think the guidance, it will be there, it'll be quite superficial. But in the meantime, as well as working through the guidance stuff, the whole industry is now working out what options are open to investors? How we can rethink the retirement income conundrum. How we can tradeoff investment returns and risk to give people a good mix in retirement to take advantage of these opportunities.
Wall: And what are the options that they're coming up with? I mean, what do people who are retiring now – what are the options available to them?
McPhail: So some further down the line, I think we're going to see perhaps some slightly esoteric solutions whereby I'll pay you no income for the first two years and then there's a 50% chance that I'll be able to give you an escalating income from thereon in, but it'll depend on market levels; the slightly weird and wacky stuff. Now I'm not sure how much of that will actually ever see the light of day, but that's the kind of stuff that's going on at the moment and maybe…
Wall: But wasn't the whole point of this system to simplify things?
McPhail: Yes. And at the end of the day, what investors want is generally fairly straightforward. A lot of people want security and certainty, but I think they will also be interested in some flexibilities, some asset backed returns and so we may see people taking tiers of income, some State Pension, maybe some guaranteed income that could be in the form of a conventional fashioned annuity or perhaps an asset backed arrangement with some sort of counter party underwriting a risk to deliver that guarantee. And then maybe some fluctuating income that will be purely sort of equity market based, and if the funds do well and if the stocks go up, you'll get more income, and if the dividends are high, you'll get more income and in the poor years, it might less.
So, tiers of income to give people the security where they need it and some flexibility where they don't all designed to try and maximize returns. I also think we will probably start to see people annuitising a little bit later in life. That trend hasn't really kept up with improvements in life expectancy, so perhaps more people working through into their late 60s, their 70s and choosing not to buy an annuity perhaps until their 70s or even later.
Wall: I mean you did mention the State Pension there. There are always people who are going to be on the rumour mill about this. They are all saying that with this introduction of this non-annuity system and also with the implementation of auto-enrolment the year before last that we are eventually going to see the State Pension go. I mean, do you think that's where we're moving towards?
McPhail: No, I don't. So, I'm very comfortable that for now and for the foreseeable future the State Pension is going to be there, and I think in some ways the Budget announcement makes the State Pension more secure, because if you're going to give people their money back and allow them to go buy Lamborghinis or whatever they want to do with their money, then the security of that State Pension income at the bottom tier becomes that much more important.
What I think we are going to see though going through next year and beyond is a rethinking of the tax breaks on pensions. And the trade-off has always been ‘we're going to require you to buy an annuity with your pension part, you lose control over the money and in return, we'll give you some nice generous tax breaks, tax relief on your contributions to encourage you to put the money in in the first place’.
Well, that equation is changing and I think the next conversation we're likely to be having is, is whether it's still reasonable to give higher rate tax relief to higher owners for example; that one is looking like, it's under imminent threat?
Wall: Of course, the annual allowance and the lifetime allowance have been reduced. Will we see this perhaps shaved off again?
McPhail: Perhaps. I mean, I think the lifetime allowance has reached almost a point of outliving its usefulness and I think there are good arguments to say there might be some trade-off between changing the tax breaks on the pension contributions, possibly getting rid of the lifetime allowance.
We need to rethink the annual allowances, some complex interactions with the new pension freedoms and the risks of people taking money out of a pension, running back around the front of the building and putting money back in again and getting more tax relief, then out the back door and back in and just recycling this money. So, the Treasury is having a real head-scratching moment, trying to work at how to deal with all this sort of stuff.
And that's why I think the reforms are good news in terms of the flexibility they are going to give people in terms of putting the money out, but a consequence is likely now to be a rethink on the tax breaks on the money going in in the first place, perhaps.
Wall: Tom, thank you very much.
McPhail: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
