Budget caveat: sting in the tail for savers and pensioners

Mar 20, 2014
The Conversation

People will need to be much more financially literate or there'll be a new pensions crisis, says Iain Clacher

THE CHANCELLOR of the Exchequer, George Osborne, “pulled a rabbit out of the hat” for pensioners and savers with changes to UK pensions that have been hailed as the most significant overhaul to the system since 1921. Simply put, the Chancellor is trying to give the 13m people who find themselves in defined contribution schemes more choice in how they invest their money in retirement.

After the budget announcement, those retiring in a defined contribution scheme will no longer be forced to buy an annuity to guarantee them an income over their retired life. As well as this, the 55% rate of tax charged on lump sum withdrawals over 25 per cent of the value of the pension pot will be abolished, and any withdrawal above the 25% threshold, will now be taxed at the marginal rate. Are these sweeping changes? The answer is yes. Whether they are good is another issue.

A new annuity regime

Choice is always seen as good. Current annuity rates mean that for £100,000 you will get circa £4,500 for every year that you live, so if you live for three years in retirement you lose out, but if you live for 35 years, you gain. Moreover, if you were to take £4,500 from the pot each year as income, ignoring any sort of interest or investment returns, it would last just over 22 years. Current annuity rates are clearly not attractive for pensioners, and prior to the Budget, pensioners were locked into these rates by law.

Individuals now have the choice of how to invest and structure their retirement. However, if individuals get these calculations wrong, and say take £10,000 a year as they expect to live for a decade in retirement – if they live for 20 years, they have a serious problem. The pot will be empty.

One advantage of pension vehicles, such as annuities, is the money is locked away. Ease of access is a problem, as a rainy day is always lurking around the corner. The money in many instances will be whittled away because of normal things that happen over the course of ones life. Broken washing machines, expensive MOTs and so on will naturally erode the pot. This security has now been removed.

A new crisis lurks

Other changes for savers such as the increase in the ISA threshold are clearly good news for savers. Individuals can now save up to £15,000 per annum, whether it is in cash or in shares. However, for most people, cash is the common savings vehicle as it gives them liquidity against life events. Where cash is the investment of choice, the problem remains despite today’s announcement; that the rates of interest on deposits in the current climate are negligible. In real terms, saving cash in an ISA has eroded the value of the money since 2008 as they generally pay interest of one per cent and inflation has been around three per cent.

So the question is: has George Osborne really “pulled a rabbit from the hat”? The short answer is yes from a political momentum point of view. He has clearly set himself on the side of savers and pensioners and his comment of “you’ve earned it, you’ve saved it. This government is on your side”, will definitely ring true with many people who have been affected badly since 2008; or who are staring at pitiful annuity rates as they look to retire in the coming 5-10 years. For savers, the changes to the ISAs look good, but until banks start providing them with decent interest rates on deposits, there will be no tangible benefit to increased levels of tax-free savings.

More worrying is what happens to those individuals who can now make choices about how to spend their pension pots. Choice may be a good thing in theory, but those about to retire will need to be much more financially literate to understand the decisions that they are making. As well as this, they will need to be given good advice from the finance industry and not just sold another product. Otherwise, there could be another pensions crisis on the horizon.

Iain Clacher is Associate Professor in Accounting and Finance at the University of Leeds.This article was originally published on The ConversationThe Conversation

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...this welcome development will now serve to highlight the folly of the previous financial services regulator, the Financial Services Authority (FSA), in that it inordinately harassed and pilloried Independent Financial Advisors (IFAs) while ignoring the excesses of the Banks.

Due to the past hostility of the FSA to IFAs a mass exodus from the independent financial advisory sector was the inevitable result and we now have a dearth of qualified and experienced advisors. With almost immediate effect we will now see a multitude of recently retired individuals, with little or no financial awareness, seeking advice with regard to their new wealth. Add to that consideration we have the overdue easing of restraints on ISA limits. This will expose a potentially disastrous shortfall in advice available to the "savers and producers and prudent individuals" that Osborne refers to.

The banks, naturally, will target these individuals. Its was (and still is!) those very banks who were the main offenders for giving bad advice - disproportionately so when compared to the numbers of banks/IFAs.

I applaud Osborne for this move but I deplore the obduracy of the previous boss of the FSA (now the FCA) - one, Hector Sants, who presided over a failed and not-fit-for-purpose organisation.

It was Sants who denied that there would be any problems arising in the future from the Retail Distribution Review (RDR) which his organisation forced upon the Financial Advisory community, on entirely specious grounds.

When challenged on the "recklessness" of the RDR by Andrew Tyrie of the Treasury Select Committee, Sants merely sat and smirked and promised to "review" his findings (with absolutely no intention of doing so). Indeed, at that Treasury Select Committee enquiry, Sants' deputy (who was such a nonentity that her name escapes me) was rebuked by one of the Committee for "smirking", when the matter under discussion was one of such manifest importance!

Sants received a knighthood for his failure, many IFAs threw in the towel and our politicians failed to grasp the enormity of what was about to unfold. They (and we) are about to discover just what a treasure we discarded when we allowed the FSA to decimate the Independent Financial Advisory sector - the banks simply are NOT of that calibre.

In summary, therefore, Mr Osborne - nice move, well-intentioned but it will now become a victim of unintended consequences which, sad to say, were warned of well in advance.

As a footnote - I foresee a boom in "buy to let" property prices - after all, recent retirees will sensibly seek to invest for a competitive income and "buy to let" will be a natural choice for many of them.