Kevin Hollister: The pension freedoms are great, but how can they work better for people?
Kevin Hollister, founder of pension calculator site Guiide, discusses pension freedoms and how they can work better for the everyday person.
Pension freedoms have been around for more than five years. So far, the pension industry has been slow to respond to people’s needs in retirement
To understand what people want from a retirement income, we need to consider how pensions used to work for most people.
Before the 1990s, most people who received a company pension had a final salary arrangement. The benefits from these were great – they paid out a proportion of the final salary people earned when they retired, based on the number of years worked for the company offering the scheme.
They also had another great feature: people didn’t need to think about anything! When they retired and started taking a pension, everything was done for them. All they saw was an income, just like a wage, hitting their bank account each month for life.
Gradually, defined contribution (money purchase pension pots) replaced final salary schemes as the norm for company pensions. Instead of receiving a proportion of final salary in retirement, a pot of money builds up based on the contributions that the employee and the company make. That money is invested, so by the time people get to retirement, their pot will include their contributions, their employer’s, plus investment returns.
Until the mid-2010s, nearly everyone had to convert their pension pot into a guaranteed income for life (called an annuity). Annuities were unpopular for many reasons, but again they had one great feature. People didn’t need to think! People bought one and after that, the money just hit their bank account each month for life.
The State Pension still works in the same way, it’s paid from the State Pension Age like a wage, with nothing more to think about.
In 2015 everything changed. New rules meant no-one had to buy an annuity at retirement unless they wanted to. Instead they could take it all as cash, or by using drawdown – which leaves the money invested, but lets people take a regular income from it.
Talk of Lamborghinis was maybe overhyped, the majority of people with total pots over £50,000 are being sensible. Most people now use these pots (along with the State Pension and other income and savings they may have) to provide an income each year for life using the drawdown option.
However, people now need to think about very difficult things like never before, things like:
- Where should I invest my money in drawdown?
- What is the most tax efficient way to take my money?
- And perhaps, most crucially, how much should I take each year to avoid running out of money?
People don’t need to do this thinking themselves, they can pay for a financial adviser to do all the thinking for them. That’s the best option but at present for whatever reasons, around half of retirees choose to do it all themselves. This is really hard to get right as it’s very complex. It also takes time and most retirees have better things to do, like enjoying retirement!
Is there a way for the pension industry to support retirees more?
There is already a lot of help available when it comes to investing pensions. Most providers offer ready made investment funds, which are designed by experts. Most people choose one of these, rather than having to think about this bit themselves.
However, when it comes to how to take the money each year to avoid overpaying tax and not run out of funds, there is currently almost no help. What if it was a simple as:
- Providing people with a good option for how the total income should increase to match typical retirement spending
- Minimising the type of tax the person is most worried about
- Solving the numbers for them to give them a total starting income now which is likely to last over a lifetime (including everything else that may come into payment later like the State Pension etc)
Then instead of asking them to request how much they want and fill in various forms, just pay out the amount needed each month until the person says otherwise. Also tracking they are still on course not to run out of money.
The feedback we at Guiide receive is that people love the Pension Freedoms but many also want the good points about the old days when they didn’t need to think.
People are happy not to have to think about investments and just let the experts do it. Can the same be done with withdrawals? Building a plan for people and just paying the amount needed each month, with the flexibility to take more if needed and see if it’s still on track would seem to be the ideal way for people to get the best of the old and new worlds of pensions.