Budget 2014: Our response

Flexibility in the retirement income market

George Osborne’s revolutionary budget has been delivered and over the coming days and weeks the finer detail will emerge and the dust will begin to settle.

In the meantime, here’s our update and our view on why we think that annuities will remain, for the majority, the most secure option of guaranteeing a lifelong income. People will still need a retirement income and advisers will play a key role helping people to make responsible decisions on how to secure that retirement income.

The key changes

Changes from 27 March 2014 to defined contribution (DC) pension pots:

• Income drawdown maximum income increases to 150% of GAD tables (from 120%). We believe this wider flexibility will also be extended to our investment-linked annuity.
• More people will have access to flexible drawdown where withdrawals are unlimited. Currently people can only access this if they have £20,000 ‘secure’ income – that limit falls to £12,000.
• More people with small pension pots will be able to take them as a cash lump sum (25% tax free the remainder taxed as income).
• Under triviality the main limit increases from £18,000 to £30,000 where people value all benefits they have across all contracts.
• The size of a small pension pot that people can take as a lump sum under triviality has been increased from £2,000 to £10,000 regardless of total pension wealth, with people being able to cash in up to three pots (previously two).

Changes from April 2015:

• People will have complete flexibility, once they reach age 55, to take their benefits when and how they see fit. 25% will be tax-free with the remainder being taxed at the individual’s highest marginal rate.

Other changes:

• The minimum age from which retirement benefits can be drawn will increase from age 55 to age 57 in 2028. Thereafter it will increase in line with increases to state pension age, so that it is always 10 years below State Pension Age.
• There will be a ban on transfers from public sector defined benefit schemes to defined contribution schemes. Many defined benefit (DB) members may be attracted by the new flexibility in DC and as many of these schemes are unfunded, any mass exodus would cost the Treasury significant amounts.
• A consultation will take place to decide if there will be a ban on transfers from private sector DB schemes.
• A consultation will take place on whether to allow tax-relievable pension contributions to be made after age 75.
• The ISA limit will increase to £15,000 and there will be complete flexibility around how much is held in stocks/shares and cash. And transfers will be permitted from one type to another.

Our view

While people will have much more flexibility from April 2015, many people will want at least some level of secure income for life – a hedge against living too long. Many retirees are naturally conservative so while increased flexibility may have some appeal, they will also want to make sure they have long-term guaranteed income.

The reality is simple – there is no other product in the market that offers such a high rate of return for life than an annuity. And this is the reason why annuities have been the backbone of customers’ retirement income in the UK.

People will need tax planning as to how and when to take their benefits. While taking it all in one go may sound appealing on an emotional level, this means you are likely to pay more tax than taking it gradually, as and when you need it. People don’t like paying tax and so they will want to phase income over a longer period.

While the new rules will allow people to strip assets out of pensions, we have yet to see the Financial Conduct Authority’s (FCA) view on when it will be suitable to do so, and how advisers will be policed in this area. For example, the FCA is unlikely to be comfortable with money being stripped out of a pension at age 55 to be put into a bank account.

This new focus on greater flexibility, and the increased focus on taking advice/guidance around options at retirement, is likely to drive many more people away from their holding provider. So while the annuity market may decrease, much of that decrease will be in the rollover market and it will have less of an impact in the external market in which we operate.

We are optimistic that our Flexible Income Annuity (FIA) will have greater flexibility in future, allowing people to take income from a bigger range than is currently available. This greater flexibility, plus the investment control and the benefit of adding in mortality subsidy, makes it a strong solution.

In summary

We fully support people having greater freedom over how they access and spend their pension savings. However, with that freedom comes a huge risk and the possibility of unintended consequences.

And advice will be key in helping people take advantage of flexibility while ensuring they have a sustainable lifetime income. We look forward to participating in the government consultation and to talking with others about how annuities and new retirement solutions will meet customers’ future needs.