Director general, IoD
Chief executive, FairFX
Fine wine buyer, Woolf Sung
Deputy chief executive, WMA
Founder and chief executive, RateSetter
Senior adviser on financial services policy, IoD
Managing partner, Neglect Assist
Managing director, Stanley Gibbons Investment
Corporate pensions relationship specialist, Scottish Widows
Dean, Henley Business School
SIMON WALKER Good morning and welcome to the Institute of Directors. Our discussion is on a topic of central importance to the business community and wider British economy. Pensions and retirement planning are high on the agenda of employers and employees and I’m sure this morning we’ll benefit from a range of experiences. The chancellor’s radical reforms to the annuity machine divided political debate and were heralded by many as either visionary or reckless. The debate raises questions about the relationship between individuals and the state, the changing nature of employment and the demographic challenges that we face. It’s also a matter of enormous economic importance.
We need to ask ourselves whether we, as a country, are prepared to face a future in which our children and grandchildren will have an entirely different understanding of retirement and what it will bring. A recent study of the attitudes of American 20-year-olds found more of them expect to have contact with alien life than expect to receive social security in their old age. The processes driving this change are obvious. Older people are returning to the workforce, not just to make ends meet, but to contribute.
It’s not clear whether legislation is driving changes or reacting to it, but one thing’s for sure, retirement planning has become more than just picking a pension pot, and it’s starting to be on people’s radar at a much earlier age. Today we’ll explore these issues and hear from the experts at Scottish Widows, and I’m very grateful to them for sharing their time. Let me hand over to Robert Cochran, the corporate pensions relationship specialist at Scottish Widows.
ROBERT COCHRAN Thank you. Pensions freedoms has been quite a big issue for Scottish Widows and the Lloyds Banking Group. We have 500,000 customers who were aged over 55 on 6 April and the concern for us was whether they would all want to come and take their money out. Initially there was a dash for cash, but we are beginning to get beyond that. We don’t yet know what the new norm is and we’ll explore that today. Do we think the freedoms are right? You can see from the way that the general public reacted, that it looks like the right thing for them. Whether customers and the general public will make the right decisions is something we’ll learn in the longer term.
Walker How good is the British pensions system? Any views on that?
RHYDIAN LEWIS The challenge with pensions is they were very good when they were designed, but perhaps they’re no longer as relative to people’s lives or the way they want to manage their money. There are two things – the performance of the actual investment management and the structure of it.
COCHRAN We’ve seen the decline of defined-benefit schemes, which were great, but very expensive for employers, and we’ve seen the rise of auto-enrolment. Auto-enrolment is based around people not having to do anything – employees get put into a scheme and they make contributions. The general public is still going to have to make decisions at retirement. The question is whether they’re equipped to do that or not.
IAN STRAFFORD-TAYLOR Pensions have to be demystified for people. I want to know what I’m putting my money into, how much I’m going to get back, and at what age. I don’t think the general public are equipped to make these decisions.
TIM WIXTED The theory of the old system was fantastic – the final-salary scheme as well as defined benefit and annuities. When you retire what you really need is a fixed income for the rest of your life. That’s what people want, isn’t it? Auto-enrolment is a fantastic idea and I think by 2018 there’ll be guarantees that employers and employees will have to contribute. In 30 years’ time hopefully we’ll get back to a situation where we have something similar to final-salary schemes.
Walker Why does it have anything to do with employers?
COCHRAN Employers are important choice architects – they help to decide what their employees do. In Australia, all the contribution comes from the employer. Here, the minority will come from the employer. The challenge is for self-employed people who are making fewer aggregate contributions to pensions every single year.
KEITH HEDDLE I don’t think what we [employers] are doing is enough and at an early enough stage. It’s about getting individuals to take responsibility. I teach an entrepreneurship class in an Oxfordshire school, and although it may seem too early to be teaching children about pensions, everyone needs to take more financial responsibility, rather than our default position being us turning to the chancellor and saying, ‘What are we going to do
LEWIS The only way to encourage engagement is to make people responsible for managing their own money, perhaps even forcing people, including younger individuals, to be responsible. We assume people can’t grasp these financial concepts, but they can. A lot of the mystery doesn’t come from the concepts and risks, it’s the layers of presentation that put people off.
COCHRAN That’s not something I agree with. Look at the Swedish model; they brought in auto-enrolment and had heavy advertising to encourage people not to use a default fund, saying it was all about freedom of choice. But by and large, the people who didn’t invest in the default ended up worse off because they couldn’t make the right decisions. I don’t believe that people are necessarily equipped. We don’t make it difficult for them to choose the funds. We create a default, which we think is the best, but they’re free to select any fund at all and that’s made perfectly clear to them. Over 95 per cent will choose the default fund because they don’t want to take that risk.
JOHN BOARD It’s hard to say whether things are better or worse because there have been so many changes. The switch from defined benefits skewed everything, so we’re almost starting from scratch. You almost want to say to people, ‘You’re going into the default unless you’ve got a good reason not to’, rather than telling them they can do whatever they like.
COCHRAN The only problem is when people get to retirement – if they haven’t engaged in their pension they’ve now got someone to blame. People will say, ‘I was in your scheme, I made contributions and now I haven’t got enough money in retirement’.
BOARD If you buy into the default scheme as a conscious choice at the age of 50 or 55, then you live with it. But you’re completely right. How on earth do you ascribe blame, either on yourself or the advice you’ve received, for something that’s going to kick in 20 years after you made the decision?
MALCOLM SMALL Freedom of choice transformed the way IoD members looked at pension saving. They went from being sceptical to being very interested. The number one issue members had before freedom of choice was the requirement of buying an annuity. People love that it’s for life, but hate that their money goes to an insurance company and dies with them. So the idea of inheritability of pensions has absolutely engaged people.
COCHRAN We researched 5,000 people and the majority wanted the guaranteed income for life in retirement. When people come to making a decision, they suffer from big-number, small-number syndrome. They’ll say, ‘That’s my pot, and it’ll deliver me X income and it’s not very big. And I don’t know how long I’m going to live’. They walk in wanting a guaranteed income for life and realise they’ve opened Pandora’s box and have a whole range of options – that’s the challenge of freedom of choice.
Walker The last pensions minister [Steve Webb] said you’re free to take out your money and buy a Lamborghini. Are people doing that?
COCHRAN The average payout has been more Ford Fiesta than Lamborghini. Less than £20,000 is the average. When I’ve seen large funds going out, they generally go overseas – people putting their money into a different tax regime.
JOHN BARRASS Cultural change is going to take a long time. By the time the 25-year-olds are 50, they’re not going be thinking in the same way as their parents. I have a 29-year-old daughter who has just changed jobs and there was a pension benefits offering, which she had a lengthy discussion with me about – how she could use the facility over a period of time and what the pension investment would be if she did this or that. She is not financially informed. She’s just a young person who is thinking about her future – if she doesn’t plan for it, nobody’s going to. And that message is getting through to the next generation.
HEDDLE Another problem is the digitisation of information and the variability of quality and advice. There’s been a polarisation of people – those who think of themselves as very well-informed when perhaps they’re not, and people who are afraid to make a decision because there’s so much information available.
BOARD The worst case would be that we start thinking about pensions like a gas bill, where you have companies coming to you, saying you can switch every six months.
WIXTED Investments are complicated and most people are uncomfortable with them. You need a default option and most people seem to be going for that, but the worry is that the default option now is effectively flexible drawdown. Annuities are so unpopular that people ring up their pension provider and say ‘I don’t want an annuity, what are my options?’ And the response is that they can take all the cash and be taxed on it or opt for a flexi-access drawdown product. But the problem is they’ve got to decide how to invest it, with or without advice.
Walker Where will we be in three or four years’ time?
WIXTED The average member of the public is scared about investment decisions so they’ll go with the default option, which will be probably flexible drawdown, which is managing your own pension pot. Essentially your pension provider will offer you several managed funds and you’ll have to make a choice. You may take advice but invariably these managed funds are invested in the stockmarket or government or corporate bonds and they’re all tradable, volatile assets. The stockmarket’s doing well at the moment but in the next five years there’ll be a dip probably – and a lot of pensioners will get burnt.
SMALL I’m a non-executive of B&CE insurance, and one of the things we’ve been grappling with is that the default position for our members – and they’re blue-collar members with small pots – is drawdown. There are schools of thought that say when you start drawing on a pension, you should be in risk-free, or near risk-free, assets.
COCHRAN We have flexi-assets drawdown. We’ve been surprised at the level of take-up because it’s not the only way you can do it. You can actually take chunks out of your existing plan and leave the investments where they were before at no cost. You can just take the money out, it goes into your bank account and it’s whatever your bank charges you – there are no product costs.
OLIVER BANKS In terms of the alternative market, two or three years ago we found there was an increase in trade because there were low interest rates, inflation was quite high, and the stockmarket wasn’t great, meaning people wanted to look at alternatives. I think it could be interesting in a few months, to see if more people will start looking at the alternative sector, particularly fine wine. There are tax benefits – there is no VAT, or duty and, more importantly, CGT can be deferred on certain products. We predict that there might be another increase in the alternative market like we saw a couple of years ago.
Walker Are there other alternative investments that people would see as savings vehicles?
BANKS Art and classic cars perhaps. It’s very important for people to keep their money in the UK. Some people have placed a lot of money into property abroad, but although we’re not a regulated market we can promote a product that is UK-based. That’s important for everyone, whether they’re regulated or non-regulated.
STRAFFORD-TAYLOR When I was growing up children were expected to look after their parents in later life, whereas now most people with a pension just want to make sure they have enough money to see them through to the end and the children can look after themselves. I don’t know how that’s affected people’s decisions but you see it all the time – you almost want to go out with nothing.
COCHRAN In some instances we’ve seen a reverse pressure created by these freedoms so that people with children who can’t get on the housing ladder are thinking about using their pension to help their kids.
BARRASS That’s important, because people are working much longer. Pension age is cutting in while people are still employed, and they’re not working for an extra year – it’s five or 10 years. It’s a situation where you have a fund that can pay you if you want but you don’t need it because you’ve got an income. People have this pot of money that belongs to them that they can use or pass on to loved ones.
COCHRAN For employers, there are other issues. Lots of people will be in employer schemes and when they get to 55 they could still be working for the company but able to take all their money out. If people do that when they’re still working, a problem arises when they reach retirement age and have no money left. They then can’t afford to retire and it creates an ageing workforce.
Walker What about over-55s who have taken the money out to start businesses themselves or move on to other careers?
COCHRAN People are already doing that under income drawdown. Our research shows that people often want to do a job that is less stressful when they get older. They might want to work part-time or supplement their income from their pension fund.
Walker What other countries have got it right? Are there things we can learn from other nations?
SMALL The best pensions nation on the planet, by dividing the total pension funds by the available population, is Australia. And they have had compulsory pension savings since the late Nineties. That has endowed Australia with a pension fund that most UK citizens can only dream of.
COCHRAN I wouldn’t agree that they’re the best nation. They’re accruing money, but their tax system is complicated and there are means-tested benefits. People are encouraged to take their money out, so they’re seeing a large number of people running out of money in retirement. The Dutch and the Danes are about collective responsibility, whereas the UK is moving towards individual responsibility.
Walker Is there a big switch towards the popularity of ISAs versus pensions?
COCHRAN Capping contributions into pension schemes will drive more activity towards ISAs, and I expect over the fairly short term we call them PISAs or Pension ISAs.
BARRASS The tax situation is what you’ve got to sort out. There are caps for ISAs but even after the changes, if you have long-term savings and investment products, and you want to be able to switch between the two, maybe you should be able to do so.
BOARD If people tend to make unwise choices should the ultimate responsibility for what goes on still be with government, in terms of setting the tax rates and regimes? That’s a hugely interesting question.
Walker Do we expect higher rate tax relief on pension contributions to survive?
COCHRAN I don’t think it’ll be here in a year. But it would be good if we landed on something that wasn’t basic-rate tax.
BOARD Doing something like that has short-term benefits in terms of raising cash. It starts skewing the pension decision itself, doesn’t it?
WIXTED Apparently the Revenue’s going to do very well out of the freedoms. In two years, with all the drawdowns and money being taken out, there’ll be an extra billion in tax that pensions will be paying.
COCHRAN It’s more the lump sums that people are taking out. If you’re taking a drawdown and you just take your tax-free cash you’re not paying anything and that’s predominantly what people are doing in drawdown now.
Walker What’s the British pensions regime going to look like in five to 10 years?
WIXTED I think when the markets fall in the next couple of years it’s going to get really bumpy. But in the long term, with auto-enrolment, I think it will be very good.
BARRASS What will change is the concept of pensions being done for you to being something that you have to manage. What we’re finding in our industry is the sheer quantity of online activity by young people in investments. Everything is
done on the phone as they walk down the street. The concept of your pension as an investment that you manage for yourself
is going to stay.
HEDDLE We’re going to end up with a different pension/investment customer – someone who is a lot more engaged. What we’re finding with the younger generation is they want things in less detail. Because of digitisation they’re used to reading things on smartphones or tablets, so they want information in bite-sized chunks.
BOARD There’s a question about the word pension. If you take employers’ contributions out, the word stops having a real meaning. It’s all about long-term investment, and if you can make that change, the whole debate could be completely different in five years’ time.
Walker Thank you all very much. It’s been a useful conversation and we’ve covered a lot of territory. Robert, let me turn to you to conclude the discussion.
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