Pension reform: with great power comes great responsibility

I was probably wrong; or at least partly so.

In 1995, I was marketing manager of the insurance company that launched the first pension drawdown plan. At the time, although heavily constrained by regulation, it was almost universally welcomed because it released people from the tyranny of purchasing an annuity. The new rules meant that individuals could draw an income directly from their pension fund.

This was important, because by 1995 the rates for an annuity had plummeted from a high of £14 a year for each £1,000 of an individual's pension fund, a decade earlier, to about £10 a year. (The level for a 65-year-old is currently nearer to £5.50 a year for each £1,000 of pension fund value.)

At the time I, like many other pension professionals, argued that the requirement to take draw an income between 35% and 120% of an age-adjusted figure set by the government was overly restrictive and that people should be able to take as much from their pension as they wanted to. Since then, there have been several relaxations to the rules; but recently, everything changed again. Now the gloves are off and the degree of flexibility available to individuals is almost everything that we had wanted in 1995.

You should, perhaps, be careful what you wish for. We now face the prospect of individuals having the ability to take all their pension fund in one go and blow (or invest) the lot! An annuity is a guaranteed income for life - taking money directly from a pension fund offers no guarantee that you will not run out of money.

Of course, there will be a tax charge on all but the first 25% of the pension fund. This means that the money taken, added to other income, could push an individual into the 40% or even 45% tax band. Tax is always potentially due on the other 75% of the pension fund - whether drawn directly or via an annuity. But if taken more slowly, it might be possible to limit the impact of tax by staying below the higher rate trigger points.

I formerly belonged to the side that argued for greater freedom, on the basis that:

a) The money belonged to the annuitant, so he or she should have the choice; and
b) It was either tax neutral, or could even generate more tax for the revenue.

There is however a potential fly in the ointment. If people do run out of cash, they might expect to come back to the state for support. Of course, the new state pension system is intended to provide an income roughly equal to the current level of pension credit, so that there could be no additional demand on the state. But in reality, despite the 'triple lock' indexation (the least of NAE / CPI / 2.5%) this is unlikely to keep pace over the longer term. Even if it did, the new basic state pension is not very generous, at about £148 a week for an individual.

More importantly, those currently approaching 65 may NOT automatically receive the new figure on retirement. Those who were contracted out of the State Earnings Related Pensions Scheme (thus paying a lower national insurance contribution) will only get as much as they were entitled to under the old scheme (unless they are able to make more contributions under the new scheme, which most cannot).

The key issue is now that those approaching retirement become a target for people trying to get them to take their entire pension fund out, even when this is inappropriate. We may need tighter regulation of those advising in this specific area, to ensure that people really understand what they are committing to when retiring. The Financial Conduct Authority, which replaced the Financial Services Authority which arguably failed to prevent all the bank's abuses in the first decade of this century, needs to monitor matters very carefully.

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Stephen Phillips is a member of the Shepway Liberal Democrats, and his views are not necessarily those of the Party. He has been writing professionally for many years on investment and economic related issues, and has focussed recently on creative writing.

You can find Stephen online at www.phillips-writer.co.uk