Pensions......"Revolution"

It has been described as the Chancellor George Osborne “pension revolution”, which will result in a sea change in the way people access their retirement savings to fund their retirements.  Under the coalition government’s proposal, from next year, millions of people with defined contribution pensions reaching the retirement age will be totally free to spend their pension pot in any way they wish.  Without doubt, this is a radical change to the previous regime, which compelled many retirees with defined contribution pensions to buy an annuity, a financial product that gave them a determined annual income for life.

 Indeed, this pension reform enabling retirees on mass to spend their savings accumulated through their working life in one go, rather than in regular installments over their lifetime is most likely to have widespread social and economic implications with some clear winners and losers.

Probably the vendors of those expensive two door sports cars are gloating over the prospect of pensioners flocking into their showrooms with a stack of cash ready to buy their new set of wheels.  But while Pension Minister Steve Webb may have grabbed the headline when he said that pensioners should be free to buy Lamborghinis if they wanted to, in reality that is unlikely to happen. Looking to the land down under, Australia, where there is no obstacle to pensioners being able to withdraw lump sums of money, recent evidence indicates that most retires opt to either invest their money, or pay back debts. Only a few splashed it out on an expensive sports car or holiday homes.  So maybe Chancellor George Osborne might have a point when he said that new pensioners can be trusted to manage their own finances.

But with more freedom of choice, with pensioners no longer railroaded into annuities, that could mean a rise in DIY investment planning, in other words a boom for companies educating pensioners on investments as pensioners try and become more investor savvy with the aim of hunting out higher returns on their investments. So investment planners, educators could be the clear beneficiaries to the pension reforms. However, the down side here is that pensioners could also become prime targets for scammers.  Unscrupulous rogues offering bogus investment opportunities maybe lured into targeting pensioners even more, knowing that they have access to funds.

Demand for higher yielding investments will be even higher following the pension reforms. So perhaps there might be a boom in the buy to let investment market, according to Mark Giddens, partner of accountancy firm UHY Hacker Young. However, a recent report by the City watchdog’s review of annuities throws cold water on that view. Apparently, the average pension pot was only £17,700, according to the report, which would not be enough for even a deposit on a garage in London.   If pensioners start scouring for higher yields, this could also mean a greater risk to their capital. "Unfortunately, as is often the case that the higher the yield, the higher the risk," said Mr Giddens.   This might means an increase in demand for share investments over bonds, the former being viewed as a higher risk asset class.  Nevertheless, there will be the State pension to fall back on should their investments turn sour. Indeed, the new flat rate state pension of just over £7,000 a year, viewed as generous by the Chancellor, will be there to lean on.  So perhaps the strategy is to encourage pensioners to take more risks, not on the road with their Lamborghinis but rather with their investments in the economy.  Surely every economy needs risk capital to grow, but it seems rather odd to turn to the pensioners for this.  In any case what this might mean is that demand for investment planners with successful track records, under all market conditions, maybe higher than ever.

The Treasury is also going to be a big beneficiary of the pension overhaul. Certainly, pensioners will be free to withdraw their pension pot, but only after paying 40 percent taxes on the entire sum.  Furthermore, because the funds would then become part of a pensioner’s estate it would also be liable to capital gains tax, unless invested in a way to avoid the £325,000 inheritance tax threshold. So it is no surprise that the policy maker is also likely to be a main gainer. Although retirees will have the choice to withdraw their funds in small amounts over the years, stick with annuity, or alternatively seek tax planning advice. Hence, another potential gainer could be tax planners.

The pension overhaul may also improve family cohesion. Recent surveys have shown that the grandparents in many cases are helping their offspring who are struggling to get onto the property ladder and helping financially with their children/ grandchildren’s education. So the biggest recipients maybe the children/grandchildren, who could also indirectly boosts further education and housing.   

But not everyone is going to be a winner. Potential losers could be annuity companies, as pension overhaul would mean that they no longer have a monopoly market. The surplus profits that annuity companies made from a captive market maybe a thing of the past and competition may mean a better service for the consumer. "The new rules might mean that annuity companies improve the rates they offer. The excess profits made from captive customers will hopefully disappear," says Tom McPhail, of Hargreaves Lansdown. Annuity companies might also look at offering other types of financial products for pensioners such as bonds.

The radical changes to the pension scheme may be viewed as a brave social experiment that may just give the economy another cylinder to fire on. However, critics particularly from the opposition labour party have argued that the policy is reckless. It is too early to speculate whether the  critics or advocates to the pension reforms are right. Only time will tell.