Pensions: Time for the public to consider private provision?
Senior Lecturer in Financial Services at Glasgow Caledonian University
THE past is a foreign country, or so the quote goes – but in reality it is the future that many of us are detached from. Indeed, saving for a date in the far-distant future is not something most of us relish dealing with, a fact that the statistics on private pensions bear out. The latest Scottish Government Wealth and Assets survey indicated that, in 2012/14, the wealthiest 10 per cent of Scottish households owned 54 per cent of private pension wealth and the combined bottom 50 per cent owned just 2.4 per cent. The same survey shows that in 2012/2014 over two-thirds of the adult population were not making any contributions to a private pension scheme. Yet, discussion of pensions in the General Election focused on the state pension “triple lock”, with little mention of private pensions.
But what can be done to deal with this personal saving dilemma?
If there had been an election debate about private pension saving, it might well have focused on the two most significant reforms in this area in recent years – automatic enrolment and pension freedoms. Automatic enrolment (AE), an approach derived from behavioural economics, is based on the idea that where it is possible to “guide” individual behaviour to achieve better outcomes, government should do so. Research has consistently found that the majority of individuals find pensions confusing and don’t know the right thing to do, and as a result they don’t do anything. Relying on this inertia, AE is a mechanism by which individuals are automatically put into a pension scheme when they join a new employer (with the right to then opt out of the scheme). The idea is that inertia will also affect opting out, so that once in a pension scheme, individuals won’t take any further action and remain saving in that scheme.
THE evidence suggests this is working. Since its introduction in 2012, more than 400,000 Scots have been automatically enrolled into a pension scheme and, across the UK as a whole, it is anticipated that by 2020 over 10 million people will be newly saving, or saving more, as a result of AE. By contrast, pension freedoms concern what happens to individuals’ defined contribution pension pots when they reach retirement. Until fairly recently, the only option was to take 25 per cent as cash and use the rest of the money to buy an annuity contract paying an income for life. Since April 2015, in theory, anyone over 55 could take the whole amount as a lump sum (paying no tax on the first 25 per cent), or as a series of lump sums, or leave it invested and draw down an income, or still buy an annuity – and a wide range of annuity contracts are available. As at January 2017, hundreds of thousands of savers in the UK had cashed in £9.2 billion from their pension pots since the introduction of the freedoms.
So far so good you might think. And many would agree. More people are saving, and they have more freedom accessing their own money when they retire. Which is fine, until you examine the thinking behind these two policies.
On the one hand, AE, as pointed out, relies on inertia. You don’t have to make a choice about your pension scheme, the level of contributions you make, or indeed what you invest in. This is all done for you. It’s the “easy” option for those confused and unable to figure out what to do, or simply put off by the idea of pensions or thinking about old age. And research suggests many in this group believe that, as AE is a government-initiated system, the contributions and investments made on their behalf will be adequate to provide a secure retirement – so there is no need to take further action.
On the other hand, pension freedoms are all about individuals making pension choices. Should I buy an annuity or cash in my pension pot? What are the tax implications? If I leave my savings invested, where should I invest them and how much should I take out each year as income? Such issues require a level of engagement that is completely at odds with AE.
The fact is, current UK private pension policy is schizophrenic. At the beginning of the savings journey it relies on inertia, but by retirement it confronts individuals with what may be regarded as a bewildering array of choices. Free “guidance” is available for pension freedoms, but the takeup is patchy. Financial advice can be sought, but is regarded by many as too expensive.
Inevitably, those with a better level of knowledge and understanding will realise they need to do more than the basic minimum provided by AE (it is generally thought that AE minimum contributions are around half of what is necessary for the average earner to maintain their standard of living in retirement). They will also be in a better position to navigate the pension freedoms, or to pay for financial advice.
Which takes us back to the Scottish Government’s Wealth and Assets survey. Those who understand pensions tend to be those currently making private pension provision – the minority in Scotland. So perhaps, post-election, more attention needs to be on financial education and awareness. And that’s something that all of us, not just the politicians, need to focus on.
Pension freedoms are all about individuals making pension choices. Should I buy an annuity or cash in my pension pot? What are the tax issues? If I leave my savings invested, where should I invest them and how much should I take out?