Your pension freedoms
In 2014 the government launched dramatic reforms. Have they worked?
Ten years ago this month the then-chancellor announced the most dramatic reforms of private pensions for a generation. “Let me be clear,” George Osborne told the House of Commons. “No one will have to buy an annuity.” A decade on, however, many pension specialists wonder whether pension freedoms, as the policy was subsequently dubbed, is all it’s cracked up to be.
At first glance, the appeal is obvious. Previously, savers approaching retirement and keen to start drawing an income from their pension funds had little choice but to use their funds to buy an annuity. Annuity rates rise and fall – largely in line with gilt yields and interest rates – so people did well or fared badly depending on whether they were lucky about the timing of their retirement. Annuities are also inflexible: you are committed to the contract for the rest of your life and the total amount you receive depends on how long you live. Those dying early in retirement get poor value.
The dawn of drawdown
Osborne’s reforms made it possible for people to swerve these unpalatable realities by withdrawing income directly from their pension funds through “income drawdown” plans. The rest of the fund can be left invested to keep growing, and therefore to sustain further income later in retirement. And money not used before your death can be passed to your heirs very tax-efficiently. It sounds perfect, and sales of annuities tanked in the years after the pension-freedom reforms came into effect. But savers and their advisers have realised that there are significant downsides to drawdown plans too.
Most obviously, drawdown arrangements carry significant extra risk. Withdraw too much money, or suffer disappointing investment returns, and you may run out of pension fund savings well before your death. Moreover, since you don’t know how long you will live for – or what future investment returns will look like – managing that risk is very challenging. Yet most savers taking out drawdown plans do not get any professional financial advice. Indeed, the reality of drawdown plans is that savers who do follow advisers’ guidance on what a safe withdrawal rate is often find that it does not match the income they’d get from an annuity.
The debate becomes even more nuanced when you take improvements in the annuity market into account. For one thing, annuity providers have raised their game, and now offer a much broader range of benefits; in particular, there are various options for leaving money to heirs as drawdown savers are able to. It also helps that the long period of ultra-low interest rates during which pension freedom was launched has now come to an end. Annuity rates have risen accordingly. Given these shifts, annuities have come back into fashion. Total sales of pension annuities reached £5.2bn last year, up by 46% from 2022, with more contracts sold than in any year since 2016. Clearly, when a decent level of income is on offer, many pension savers like the certainty annuities offer: a guaranteed income for life with no need to worry about managing pension-fund investments and withdrawals.
None of which is to suggest pensions freedom was a mistake – although some savers have undoubtedly made largerthan-prudent withdrawals from their funds, whether because of temptation or necessity amid the cost-of-living crisis. However, for savers pondering their options today, it’s worth going back to the chancellor’s original remarks. No one has to buy an annuity today – but plenty of people should.