Pension freedom – guaranteed to confuse?
First published 15 December 2014 • Updated 23 January 2017
Pensions in the UK are seeing their biggest shake-up in more than a century, as the Government tries to give an ageing population better choice and control over their retirement income. But with this greater freedom there may come more confusion than ever about what to do. The Government has offered a ‘guidance guarantee’ – but will it be enough?
In April 2015 we will see the biggest change to UK pensions in living memory. Chief among the radical reforms is that individuals will no longer have to buy an annuity, and will instead be able to draw freely upon their pension funds subject to only their marginal rate of tax. People can also transfer final salary schemes to defined contribution schemes if they wish, and providers will be able to develop many more products tailored to consumers’ individual needs.
The Treasury claims that around 18 million people will benefit from the new, more flexible pensions regime. This may well be true, in theory – but as any Christmas shopping trip will remind you, the downside of increased choice is that it becomes harder to make decisions.
Naturally, the Government has anticipated this. It has come up with the ‘guidance guarantee’ – the offer of free, independent guidance for everyone with a defined contribution pension scheme. Each individual will be entitled to a free consultation (of approximately 25 minutes) in which their options will be explained to them, so that they can make a more informed choice about their pension at retirement. The guidance will be provided by independent organisations such as The Pensions Advisory Service (TPAS) and the Money Advice Service (MAS).
So everyone with a defined contribution pension is to get more freedom, and free guidance on what to do with it. Problem solved?
Well, not quite. Although 25 minutes is better than nothing, it’s a very short time in which to decide the next 25 years or more. Although some individuals may finish their consultations knowing exactly what they should do, many more will end up with more questions than they started with. There may be just enough time to run through the available options, but certainly not long enough to determine how well those options correspond to each individual’s needs. In any case, proper advice needs to factor in the individual’s full financial position, and that is simply beyond the scope of these free guidance sessions.
So people will be left with a list of options, but not much more. The FCA has effectively acknowledged this in its latest paper, where it explains that consumers will then be advised on where they can seek advice that is suited to their needs. In other words, they will need to consult their own regulated financial adviser. This will, in fact, be a legal requirement for anyone wishing to transfer their final salary (defined benefit) pension scheme into a defined contribution scheme, as new safeguards are coming into force to ensure that all such individuals take advice from an IFA that such a transfer is in their best interests. But even those who simply want to know what to do with their pension pot will probably need an IFA to make sense of the choices now before them.
What price free guidance?
There is another potential objection to the guidance guarantee. Will people actually take any notice of the guidance offered them? The FCA may claim that it has done its bit and led the horse to water, but that won’t be any consolation if large numbers of pensioners end up dependent on the state because they didn’t follow up the information they were given. Gareth Rees, a chartered financial planner at GEM Financial Services, has voiced doubts about the proposed free nature of the guidance. He argues that people tend not to value things they do not pay for, and so are more likely to disregard free guidance.
Nevertheless, the guidance guarantee is a step in the right direction. It will put many more individuals on the path towards planning their retirement income, and ensure that the huge new range of choices on offer will deliver their potential benefits, rather than just muddy the waters. Yet more must be done to ensure that consumers stay on this path. To do that, they need to follow up their guidance consultation by seeking proper whole-of-market advice which is tailored to their needs. The guidance guarantee should not skip over what is perhaps the most important guidance of all: talk to an IFA.