John Humphrys asks: is George Osborne making the right changes to the pensions system?
Budgets are funny things. An enormous fuss is made about them beforehand. The event itself is one of the main fixtures of House of Commons theatre (MPs used to dress up especially for the occasion) and the media devote huge amounts of time and space to reporting what’s gone on. Yet usually they contain little that was not wholly predictable and we soon forget what that was. This year’s is hardly different, except in one respect. The Chancellor, George Osborne, announced radical changes to the way we run pensions. But are they the right changes?
For many years people reaching retirement and looking forward to drawing the pensions they had been contributing to all their working lives have been complaining that they feel trapped and short-changed. The taxation system regarding pensions has virtually forced them to use the bulk of the pension pot they have accumulated to buy an annuity: a product sold them by an insurance company promising to pay them an annual income for the rest of their lives. But to many this annuity has seemed a bum deal. The annual income has shrunk to a derisorily low level. Many new pensioners have come to believe they could generate a much better income if only they were allowed to make more of their own decisions about how to use the pension pot they had created.
That is exactly what George Osborne is promising them. From April of next year he will introduce what he called “the most far-reaching reform to the taxation of pensions since the regime was introduced in 1921.” He said: “People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances. And that’s precisely what we will now do. Trust the people.”
In specific terms he proposes to abolish the restrictions on how much people can take out of their pensions savings as cash, when they can do it and, most importantly of all, how they should secure their incomes in retirement. He hammered home the most fundamental point: “Let me be clear. No one will have to buy an annuity.”
Although everyone said the announcement came as a big surprise (it is part of the traditional theatre of Budgets that chancellors must pull rabbits from hats) it should not have done. The world of pensions, and particularly of workplace pensions, has been changing enormously over the last twenty years or more, so government was bound to react sooner or later.
In the latter part of the last century most people who had a job with a company or in the public sector could join an occupational pension scheme that would mean they were not solely dependent on the state pension in old age. Both employees and employers contributed to these schemes that took one of two forms. In ‘defined benefit’ schemes, the fund guaranteed to pay a fixed annual income to the employee on retirement, an income which would generally rise with inflation over subsequent years. In ‘defined contribution’ schemes, the fund would simply guarantee the size of the pension pot at the time of retirement, leaving the newly-retired worker to decide how to convert it into an annual income. Usually this was by buying an annuity.
In the last fifteen years or so, however, the ‘defined benefit’ version has almost disappeared for new members. The proportion of private sector employees in defined benefit schemes has shrunk from nearly 34% in 1997 to around 8.5% today.
Several things have contributed to this decline. The fact that we are living so much longer has made it more risky for companies to commit themselves to paying guaranteed pension incomes. Changes in government taxation of pension funds (notably Gordon Brown’s notorious ‘dividend raid’) have made it more costly to provide those incomes. And the low rates of return on investment, especially the low rate of interest paid on government debt since the financial crisis, have made it harder for company pension funds to generate the income to pay the pensions.
So more employees have been forced into ‘defined contribution’ schemes and so become more dependent on annuities. But the value of those has fallen for the same reasons. Increased longevity and poor rates of return available to insurance companies selling annuities has meant that the annual incomes offered for by those companies has been dropping like a stone.
What Mr Osborne wants to do is give people the freedom to see if they can do better than the insurance companies in generating an income for themselves by putting their pension savings in something other than an annuity.
Of course some people will continue to choose to buy an annuity, although the immediate sharp fall after his announcement in the share price of the main companies involved in the £12bn-a-year annuities market suggests that the market at least believes many people will make use of this new freedom.
But some commentators are voicing fears about the consequences of this. It has been suggested, for example, that there might be a rush into the buy-to-let property market by new pensioners, tempted by the current boom in house prices, especially in London and the south-east. This would inflate the bubble even more and make property even more unaffordable to the young. There’s also the risk of a new mis-selling scandal as unscrupulous players in the financial markets seek to take advantage of the sudden increase in the number of people with large amounts of money to invest.
Some are worried that new pensioners will make investments that, unlike annuities, won’t provide incomes that will be sure to be paid for the rest of their lives. The National Association of Pension Funds, which represents company pension schemes, said that there was an increased risk that “a number of people will run through their pension pots far too quickly. … We fear these reforms, without careful scrutiny, will leave a large swath of people vulnerable to poverty in old age.”
At a more basic level there is the obvious fear that people will use their new freedom irresponsibly by simply taking the money, frittering it away and having nothing left for their old age. Ed Balls, the shadow chancellor, whilst generally supporting the change, asked: “Will we have people running out of money and forced to rely on the welfare state?”
Mr. Osborne claims that other changes he is making to the state pension, raising for everyone its value to a level above the poverty line, means that future governments won’t have to fork out more money to supplement the incomes of pensioners who’ve thrown away their occupational pensions. He also believes that the new freedom he has announced will encourage more people not to opt out of the auto-enrolment system of occupational pensions being introduced in 2018.
All this remains to be seen. Meanwhile there is an obvious political dimension to his radical change. The Conservative Party, whose election campaign he will mastermind, is desperate to defuse the threat posed by UKIP, whose appeal is greatest among the elderly. These changes, along with other help on savings he introduced in his budget, is targeted exactly at them.
Whether the Budget was the best way to launch this revolution is another matter, however. Some commentators argue that so radical a change should not be simply thrust upon the world for the sake of creating Budget drama. A better way would have been to publish a consultative green paper, invite suggestions from interested parties and then come to a considered decision. But that would have been to forego the drama and publicity that rabbit-pulling chancellors so adore and which, perhaps, is the only reason we have Budget speeches in the first place. There will be another coming along in the autumn.
Meanwhile, do you think George Osborne has made the right call on pensions?
