Every month we invite the best investors we know for dinner and ask them what they think about the markets. This time, we asked five financial advisers to give us their views on how ‘A-Day’ – when new regulations come into force on 6 April – will affect our pensions.
Danny Cox: I think we will look back at A-Day in about ten years’ time and see the benefits. For the majority of people, after A-Day you can pay as much as you want into whatever pension you like; you can join multiple pensions; you can move your money from one pension into another; and you will be able to retire at 55 and not have to buy an annuity – although most people will probably still need to.
Mike Morrison: I’d agree that the regime will be simpler, but it will take two or three years before we get it all bedded in. For the vast majority of the population, things aren’t going to be that different. The investment story is going to be the same as it was before A-Day.
Robin Algar: It’s only marginally simpler than the previous regime, and people still need advice and help to wade through all the different options.
Ken Murphy: I think these options are great news, by and large. The industry has to show how positive they really are.
MM: But it won’t make much difference, except for those people who have got the wherewithal to pay higher contributions.
KM: Most people may not be able to contribute 100% of their salary, but the fact that you will be able to do it brings pensions more into a tax-planning regime than they have been. Ordinary people will have the option, for example, of paying windfalls into their pensions.
James Brooke: One of the differences is that under the current regime you can’t take your tax-free cash without also taking the pension benefits. After A-Day, you will be able to take the tax-free cash without having to draw the pension; you can even take the tax-free cash and go on contributing to a pension. So many people will be able to use that tax-free cash to pay off their mortgage at 50 or 55, but wait before retiring, which gives them more time to build the pot back up again.
Under the current regime, you have been restricted on the amount you could put into your pension each year, on a ‘use it or lose it’ basis. Under the new regime, you might choose not to put the money into a pension at all until much later in the day. For example, you might invest your money in an Isa and only move the money into a pension when you get much closer to retirement. I’m in favour of this kind of flexibility.
But at the end of the day, it’s all down to asset allocation and tax planning, not a question of whether you should have a pension or not.
MM: The concern I have is that you can draw your tax-free cash at age 50 and use it for current consumption. But then, ten years later when you come back for your income, you realise that you’ve only got three-quarters of the amount you thought you had in the first place. People will need advice.
JB: But after A-Day, when you hit 50 you will be able to take the tax-free cash, but keep on working and go on contributing, and so you can top up your future income.
DC: What we are going to see are lots of clients coming to all of us and saying – “Why do I want advice from somebody who has ripped me off with Equitable Life and ripped me off with personal pensions in the past? I know the rules of income draw-down, why can’t I do it myself?” As advisers, we need to make sure we provide people with enough information, so that they know the risks and the pitfalls – but in the end, why shouldn’t people be allowed to organise their pensions without advice?
KM: Well, no, that’s exactly where the problem lies. Income draw-down requires advice on a continuing basis, not just on day one. A lot can happen to investment returns over five to ten years.
DC: As an independent financial adviser, I think everybody should have advice on draw-down, but people should be able to choose not to take advice, if they don’t want it. We don’t currently offer income draw-down on a non-advisory basis, but there are firms out there that do. It’s one of the choices that we’re looking at in the light of A-Day.
MM: I do believe in financial advice. You might not buy an annuity on day one, but your fund might not be big enough to withstand volatile equity markets. The key is to maintain the purchasing power of your pension fund.
RA: I think with income draw-down the job’s no different to any other investment job. You’re advising on a portfolio of investments, and whether that’s within the pension regime, or a portfolio of unit trusts – Isas, offshore bonds – doesn’t matter. It’s the same job.
Annuities
MM: There’s two areas where annuity rules change. First, temporary annuities, but they’re frightening.
DC: They’re not worth looking at! I’m not even sure any product providers are actually going to do them.
JB: Except that if they are offered, as an adviser you will have to offer advice on them or risk getting clobbered by the regulator in the future.
DC: I don’t think anyone is going to offer them, but I do take your point.
MM: The second change will be to value-protected annuities – there’s a 35% tax charge on them. You’d probably do better to take out pension term insurance alongside a normal annuity to age 75 and then a decreasing term insurance.
DC: I think the overall issue for me on this is that if you talk to people about why they don’t want an annuity, they say, “it dies with me” – which is not true of value-protected annuities.
A-day positives
JB: The single best thing about A-Day is that it has got people thinking about how they are going to afford their retirement: because people don’t retire by age, they retire by income. You stop work when you can afford to.
KM: We’ll get more flexibility, more visibility and, if we do this well, the pension industry can come out of it looking pretty good too.
DC: I agree. I think that 99% of people will still need to buy an annuity, and should buy an annuity, but the fact that people no longer have to is a fantastic message for the general public.
KM: I think the idea of bringing pension planning back into mainstream financial planning is very positive. The chief reason people can’t stand pensions is because they don’t trust them, because they’ve had it fed to them that they’re dreadful things. But that’s not necessarily true. If the public could only understand that you can put your cash into a pension and get tax relief on it, they’d feel differently. It’s just a more efficient way of saving.
RA: A pension is just a tax wrapper around an underlying asset portfolio. So if you’d put all your pension into South America over the last three years, you’d probably have had a great return. You couldn’t then complain that the “pension” had performed badly.
MM: I agree. A decision to buy a pension is rarely the wrong decision. The wrong decision is what you put into it.
JB: People want to save and invest for their future, but the whole financial services business seems to have frightened them off. With-profits schemes worked very nicely until we got into the game of, ‘I want to appear at the top of the league table in paying out the biggest bonus this year – how can I get myself there’. Because the guy who pays the biggest bonus this year gets the most business next year.
It was when the product providers started playing fast and loose with future returns (by giving bonuses today based on what they hope for tomorrow) that we saw the collapse of companies such as Equitable Life, who weren’t providing adequately for the promises that they’d made. But I believe that what the public is looking for is an investment that is going to give them double-digit return with the risk profile of a bank account.
KM: Transparency is so important. We have never had transparency in our industry. And I agree that the problems with with-profits life funds are partly to blame for the public’s mistrust. However, the industry has also bought the misselling scandals upon itself. The product providers paid too much commission and, on the whole, the industry was happy to accept it.
JB: But let’s not forget that it was the FSA who said you shouldn’t opt out of your occupational pension scheme because a final salary pension scheme is guaranteed. And then when some final salary pension schemes went bust and the members of the scheme found they were only going to get a fraction of what they had been promised, the FSA came out with their famous statement, “Guaranteed does not mean guaranteed in all circumstances.”
KM: But like it or not, we have to pick up the pieces and it almost doesn’t matter who is to blame. Simplification allows us to begin the process of regaining people’s confidence.
Advice
RA: I think the biggest problem is that most people never get much advice in the first place. They should take advice and take on risk from an early age.
KM: But most people aren’t going to do that because they can’t afford it.
RA: I disagree. It doesn’t take much time to set up a diversified portfolio within a pension, and this doesn’t have to change very much over the next ten years.
JB: We use an asset-allocation modelling system and use a text-messaging system to ask them 12 questions to determine optimal allocation.
KM: But very few independent financial advisers have got anything like the capability that you’ve got.
JB: Every firm can do what we do. It’s not a question of capability, it’s a matter of will.
MM: I think that we’ve got some political consensus on A-Day. Also, we’ve got to see a greater role for the financial planner, rather than the salesman.
RA: We are now moving into a situation where people will actually get the financial advice they need. But it’s not going to happen overnight.
DC: The problem with pensions legislation is that it’s been piecemeal and reactive. I’m interested to see what happens when the Inland Revenue notice high-earners moving money into pensions in a block.
MM: European harmonisation will be an issue at some point. But the fact that more people are getting older and that their consumption patterns are more U-shaped is important, and so hopefully the changes will turn out be about real people, rather than about the minutiae of legislation.
What’s going to happen to your pension?
The pros
- For all types of pension, you will be able to take 25% of the value of your pension fund as tax-free cash (“income draw-down”) at age 50 (55 from 2010) without having to retire or take an income from the rest of the fund, up to a ceiling based on the lifetime allowance.
- You can make contributions equivalent to your annual salary every year up to £215,000, with no limit in the year before retirement. If you don’t have earnings, you can only contribute £3,600.
- You won’t have to buy an annuity at the age of 75. Any money left in an “unsecured pension” fund (pre-75), or “alternatively secured” pensions (post-75), can be passed on to your heirs.
- You will be able to contribute to both a company and personal pension at the same time.
- There will be a ceiling on the untaxed value of your pension fund, called the lifetime allowance, set initially at £1.5m and rising to £1.8m in 2010.
The cons
- Some insurance companies won’t let customers take their tax-free cash and leave the rest of their fund intact. You could switch to an alternative provider, but might have to pay high penalties.
- Not all employers will let their workers take all the benefits, such as tax-free cash, while continuing to work. You could switch to a personal pension, but there will be transfer costs and you might lose out from leaving the company scheme early.
Mind the savings gap
- As the population ages and the proportion of workers to pensioners decreases, funding pensions will become more difficult. In 2005, 19% of the population were of state-pension age; by 2055 the figure will be 26%.
- The savings gap – the shortfall between what we save today and what we need to save to pay for a comfortable retirement – is estimated to be £27bn a year, or a total of £160bn.
- The Government says it would cost £15bn-£17bn to compensate the 85,000 people who lost all, or part, of their company pension.
- Lord Turner’s Pensions Commission proposes that the state pension age should be linked to rising life expectancy, a state pension linked to average wages, and a new National Pension Savings Scheme.
- Household debt was £1.2trn at the end of 2005, £30bn more than UK GDP.
- Personal debt is increasing by £1m every four minutes.
Our panel
Robin Algar, Independent financial adviser at Positive Solutions
James Brooke, Financial planning consultant with Anand Associates
Danny Cox, Head of financial practitioners at Hargreaves Lansdown
Mike Morrison, Pensions strategy manager at Winterthur Life
Ken Murphy, Director, Best Invest