Doom-mongers are wrong on pension freedom

There is no evidence that people are blowing their pension pots – but young workers are facing a crisis

When Chancellors stand up to talk about pensions, it is rarely good news. But when George Osborne delivered the 2014 Budget and told a stunned House of Commons that people would be set free from the need to buy an annuity, the cheers could be heard around the country. Instead of having to convert their pension pot into a modest fixed income for life, savers would have new choices, including drawing as much or as little from their pot as they wanted, when they wanted.

To this day, a minority have expressed concern that this newfound freedom would lead to people running out of money prematurely, a view thoughtfully expressed in the Telegraph this week by Paul Johnson, director of the Institute for Fiscal Studies. Mr Johnson is perfectly right to point out that individuals now have to take more responsibility for managing their money, and that some will underestimate how long their

money will need to last. But I would passionately defend the principle of pension freedoms and think that the doom-mongers overstate their case.

Since the rules changed in 2015, the evidence is that people with meaningful pension pots have not blown the lot on the mythical sports car. Those who have worked hard and saved hard, frugally putting money aside throughout their working lives, have not suddenly become reckless spendthrifts at retirement. Most people with larger pension pots take financial advice, and in most cases they are withdrawing money at an entirely sustainable rate.

If I do have a concern about the pension freedoms, it is more for those with relatively modest pension savings, who are probably being excessively cautious. Research by the Financial Conduct Authority shows that those with small pots often withdraw its entire contents in one go. Their focus is often on the 25 per cent of a pension that can be taken tax free. Because of a lack of public trust in financial services, the remaining 75 per cent is often then invested very cautiously in a cash ISA or similar low-return account. While this is fine as a short-term resting place for ready cash, it is not a good idea to hold money for the long-term in these ultralow-interest accounts. That is why it is welcome that the FCA is looking hard at ways of ensuring that people do not “sleepwalk” into holding money for the long term in accounts of this sort.

But it is not even this sort of behaviour that is going to cause the real pension crisis. That will come for future generations – today’s workers – whose pension pots are likely to be far smaller. How, then, can we address their needs?

Obviously, the answer is to make sure that the young workers of today build up meaningful pension pots so that they are less likely to run out of money over the course of their retirement.

For employees, a good start has been made, with around 10 million workers automatically enrolled into a workplace pension since 2012. Mandatory contribution rates have been stepped up to 8 per cent, split 5 per cent by the worker and 3 per cent by the employer.

But this process has now stalled, and contributions at this level are unlikely to generate a comfortable retirement at a reasonable retirement age. We need to review the mandatory contribution rates, in particular by first considering whether a contribution rate of 10 per cent of total pay, evenly split with the workers paying 5 per cent and the firm the other 5 per cent, would not be a better starting point.

We also need to nudge employees to increase their contributions beyond these minimum levels as their pay rises. The behavioural science behind automatic enrolment has been shown to be hugely effective in getting people started on the pension journey. The Government would do well to investigate similar behavioural techniques to nudge contribution rates up.

For the self-employed, millions of whom are putting nothing aside for later life, a key place to intervene would be when they file a tax return. Mirroring the process of automatic enrolment for employees, the tax return process could be used to “nudge” self-employed workers into making a pension contribution, perhaps combined with their annual tax bill, while retaining the freedom to opt out. Without a measure of this sort, the lifetime self-employed – an ever-growing number of the working population – are at real risk of becoming second-class citizens in retirement.

Giving people freedom means taking a risk that they will get things wrong. But we have to start from the principle of trusting people with their own money, while giving them the support that they need to make best use of this newfound freedom. Protecting those freedoms, while also taking action to make sure that tomorrow’s retirees have enough in their pension pot to enjoy that freedom, has to be the way forward.

Sir Steve Webb is director of policy at Royal London and was pensions minister from 2010 to 2015