As part of our series of blogs to mark the launch of the new MyFS report on funding retirement, Stephanie Condra, Retirement Market Strategist at AXA IM, gives her thoughts on the ‘Easter eggs’ that have been hidden away in the last budget and in the upcoming pension reforms.
I have Easter eggs on the mind. Not the chocolate kind, though. The Easter eggs I am referring to are the hidden messages that can be found in movies and only noticed by those ‘in the know’ (fans of Pixar movies know that characters from other films often make cameos, and fans of Fight Club have probably spotted the Starbucks cup that shows up in almost every scene).
In the context of the recent budget announcement, a few of these kind of Easter eggs come to mind.
First that comes to mind is the reduction in the lifetime allowance from £1.25million to £1million. As always, the message was focused on the size of the savings pot and not on the income that it could generate. For someone retiring in the next few months, after taking their 25% tax-free lump sum from a £1million pot, they would be able to purchase a single life inflation-linked annuity of about £25,000 per year. While pensioners are no longer required to buy an annuity, this figure is a helpful indication of what they could expect to receive in terms of stable and predictable income over their lifetime. The Easter egg that can be found in this announcement might be that the government has chosen £25,000 as the level of income that savers can generate from their pension and that anything else will need to come from savings, investments or assets that have accumulated outside of their pension.
The government also suggested that from 2018 the lifetime allowance would be indexed to inflation. While this was a welcomed change that recognises inflation risk, once again this was a focus on the value of the savings and not on the income. Over the past few years, pensioners have realised the impact that interest rates have on annuity prices. As interest rates decline, annuity prices increase. A more effective change would be to link the lifetime allowance to the price of buying a certain level of index-linked income. The Easter egg here is that the only way to preserve the income purchasing power of the lifetime allowance would be to link it to both inflation and interest rates, thus recognising key risks that face savers as they approach retirement
The government also confirmed their plans to allow pensioners to sell their annuities on a secondary market. This was positioned as the final straw in the cap of pension flexibility. Defined contribution savers no longer have to buy annuities, defined benefit1 members can transfer to a defined contribution2 plan, and now annuity holders can sell their income in exchange for a cash sum. While this might appeal to existing pensioners that were not able to benefit from the upcoming reforms, there are a lot of questions related to the practicality of this solution, such as “would advice be required?” and “what information would buyers look for (and how would this be verified)?”. The complexities of implementing this proposal appear to outweigh the potential benefit and could take years to implement. For this proposed change, the Easter egg seems to be that the people that it is designed to benefit most – pensioners who did not have the option of flexibility and choice at retirement – will be much older by the time the secondary market is established and may no longer be in a position to sell their annuities by the time the legislation is enacted.
After the hunt for Easter eggs has ended, the not-so-hidden message coming out of these changes is that it is important to be educated on the options that are available. Whether individuals are accumulating their retirement savings or drawing down on the pot that they have saved, investors need clarity, support, tools and education to help them get ready for life after work.