October pensions supplement: What will follow Osborne’s revolution?

In this year’s Budget, George Osborne, the Chancellor of the Exchequer, announced that the government was making substantial changes to Britain’s pensions system. Under the new rules, pensioners would be able to take the entire contents of their pension pot and invest or spend it as they wished.

In one blow, the Chancellor removed the obligation for pensioners to buy an annuity on retirement, a product that guarantees the pensioner an income for life. This change was greeted with much surprise, both in Westminster and the pensions industry. The government later made it clear that any amount over the 25 per cent tax free cash would be taxed at the marginal rate, perhaps making the cash option less attractive.

The changes announced by Osborne will fundamentally affect Britain’s investment landscape. The pensions asset management industry needs to innovate in order to meet the challenge; Aberdeen Asset Management is deeply involved in developing answers to the complex array of questions that have now arisen.

The greatest change could well be among pensioners with savings of up to £100,000. In this bracket, the temptation to withdraw large chunks of money from the pot will be greatest. The change does provide people with more control over their own capital, allowing them to spend or plan their income requirements with a greater degree of flexibility, such as insulating their homes, which would keep running costs down.

However, it does give rise to a new area of challenge—managing that pot for the long term and ensuring that it supplies enough income to support the hoped-for lifestyle while at the same time not declining in real terms. For someone with total pension savings of £30,000, the ability to withdraw lump sums could be a far more reasonable use of funds than relying on the very modest returns provided by an annuity.

Savers with larger pension pots might also chose to make withdrawals from their savings, but five or so years later they might decide that they want to protect their capital and so take out an annuity. But then if there is a change in their circumstances, say, deterioration in the state of their health, then this might require a very different income profile and so yet another product might become necessary.

This requirement for flexibility raises a crucial issue for the pension asset management industry: what are the right investment products to manage those assets? This, we think, will be the area of greatest evolution—trying to blend the right products to secure a pensioner’s capital, provide an income and perhaps some growth in order to keep that pot going as long as we are alive.

The answer might be a product that maintains growth over time. Some retirees may chose a form of semi-retirement, an arrangement where they would draw their pension but supplement this income with part-time work.

Retirees will have a greater choice than ever before, which can bring as many opportunities as it can risks. This places added significance on the government’s new planned guidance service, also announced at the Budget, which will advise retirees on their investment decisions. It is crucial that this service can deal with the burden that will surely be placed upon it.

Yet more complexity arises due to the demographic shifts taking place in Britain. Pensioners live longer after retirement than ever before.

And now that the government has removed the singular moment of investment decision-making at the point of retirement, there is a strong chance that people will take their time in deciding what to do with their money, extending the moment of retirement into more of a protracted, phased process.

The need to preserve and perhaps potentially grow that pot with minimal risk means the very nature of retirement and planning will evolve.

People are going to work until they are older, and make financial provision for their retirement in a much more complex manner as a result.

A further issue is education. If we are to have more people making better decisions about their savings later in life, then it is vital for government to raise financial acumen in order to help people to deal with their own circumstances.

This is not just about the dangers of debt, but about the importance of savings. If the government’s well-intentioned reforms are to bear fruit, then savers, the market and government will all have to make a contribution.

But despite the Chancellor’s surprise, sweeping announcement, certain elements of the pensions industry we believe will remain the same. People with medium-sized or large pension’s savings pots will still want a steady income once they have stopped working. Annuities, though no longer compulsory, have not been removed from the range of options available to retirees—they remain a valid, if perhaps somewhat staid, option for clients.

This means that if a client tells us that they require a strong, steady return with the lowest volatility, it’s difficult to look past an annuity product. A return on an annuity might be in the region of 4 per cent. Getting that sort of return in the equity markets with zero volatility is impossible.

But here it is important for those in the market to be straight with them, and to acknowledge that it is hard to say now what clients will want. We are not yet in a position where the first ones have retired under the new rules. It will be late next year before we start to get a clear sense of what the trends are in the market.