Lessons from the past

If we can take any lessons from de-regulating mortgages and bad management by some, it is that cashing in a pension may give short term pleasure but will in the end deliver long term misery.

The UK Pension system has suffered decades of tinkering with successive governments failing to make any radical changes; instead chipping away with small changes which have made the system complex and untenable.

Changes to pensions rarely win politicians votes and often by the time legislation has gone through they are no longer in power.

For many years we have been heading towards a known implosion, and many have chosen to ignore this:

  • Annuity rates have fallen to reflect longevity
  • The state pension age is based on life expectancy set in 1946; and
  • Guaranteed pensions for all but the lucky few have gone, meaning individuals have to take control of their income in retirement.

To carry on is neglect, changing course is absolutely necessary.

“Historic savings revolution”

The announcement in the budget caught many by surprise. In the space of a few minutes the Chancellor ripped up the UK Pension manual.

Panic, especially in the annuity market, ensued as many believed these changes signalled their end. The assumption was that everyone would take the opportunity to empty their pension pot and manage the money themselves.

Phrases like “all about trusting people to run their own lives”, “path of enlightened self-interest” and “pensioners should be free to buy a Lamborghini” littered the press.

There is no doubt that the pensions system requires radical changes. Individuals should be trusted to run their own lives, but the build up to the financial crash demonstrated that this can also lead to profound problems.

For all the blame that is heaped on the banks, individuals took the “free sweets” (loans) without a care in the world, and when the party came to an end these people suffered greatly.

These changes will open up the choices in retirement but they assume that individuals will understand and know what to do and we would argue that for many this is a flaw in the plan.

De-regulation of pensions

Effectively the pension market is now de-regulated.

Auto enrolment makes it compulsory for employers to offer a pension scheme. Individuals believe that this pension will provide for them at retirement.

What they must understand is that when they come to retirement that lump of money has to provide an income for 20 plus years. An annuity for all the negative sentiment provides this guarantee, taking that compulsion away leaves the individual to choose between taking all the money out at the start or managing their pension fund to provide for an income.

Strangely where we have argued that the pension system was complex before, what has happened makes it even more so because individuals need to plan not only for retirement but also in retirement.

There are traps all the way; for example, the pension fund could be taken into consideration for providing nursing home fees (or long term care), or taking the pension fund as cash could mean paying higher tax on the way out, and then being hit twice for tax as it is then part of an individual’s estate for inheritance tax purposes.

It also raises the question as to whether the pension is the best vehicle for pension savings going forward; an individual can pay up to £15,000 to an ISA from July which will deliver tax free income and using CGT allowances outside an ISA can deliver tax free income.

We saw the disastrous impact of de-regulation of the mortgage market and these changes could over the next twenty years do the same unless they are carefully managed

A place for advice

Financial advisers have come in for a lot of stick over the last few years and its true some were no more than sales people, selling any product and moving on.

This still sticks in peoples minds years after change has taken place, and remains for many just at a time when these changes scream the need for advice. The growth of DIY investments is going only one way as we have seen with the massive growth of Hargreaves Lansdown.

There is a real appeal to DIY investments, why should an individual pay 1% a year to a financial adviser when they can pay 0.4% to Hargreaves and manage it themselves?

But is this not like saying there is no difference between buying a kit car and a fully constructed car; people assume they could easily buy a kit car and build it themselves. The reality is that many do not have the skills or time. (Often not realising this until it is too late; when the wheels come off and they crash!)

The de-regulation of pensions opens up a minefield of issues for individuals. Politicians are failing to recognise this.

Individuals need to embrace the idea of financial plans to ensure they are investing in the right way, and when they come to retire make decisions as to the best way to receive their income. If they can’t do this the plan will fail and for all the good of these radical changes individuals will be left confused and potentially worse off in retirement.

These changes should radically alter the need for advice. Paying 1% for an adviser to manage an individual’s plan both pre and post retirement may be the best investment to make.

“Path of enlightened self-interest”

The problem is that many will not see this for two reasons – firstly because they have been failed in terms of financial education and secondly many have grown up in the “free sweets” for all era.

The path of ‘enlightened self-interest’ is great if an individual understands the basic concepts around managing money on a day to day level, but for many this is a complex issue and therefore it is likely to only benefit the financially astute (which is the minority).

Where now

The overhaul was long overdue.

Individuals should have a right to control how their pension is used in retirement but the effective de-regulation of the market opens up additional cans of worms!

The reality is that retirement for this generation is much more complex. People will live for 20 to 30 years in retirement; people may work as well but more importantly whatever money they have they need it to provide for themselves during this period.

If we can take any lessons from de-regulating mortgages and bad management by some, it is that cashing in a pension may give short term pleasure but will in the end deliver long term misery.

 

NOTE: This is written in a personal capacity and reflects the view of the author.  The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

 

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