In the recent past, the pension system in the United Kingdom has undergone a shift of seismic proportions. This overhaul of the system has led to reforms in practically all aspects of saving for retirement. These changes, announced in the 2014 budget, and in operation from April 2015 have a significant impact on the way individuals make decisions relating to their retirement. The changes instituted primarily relate to auto enrolment, freedom of access to the pension savings, annuities, and eligibility to state pensions. This essay evaluates the potential effect of these policy changes on working-age individuals saving for their retirement and individuals considering how to use their savings during retirement.
One of the primary reforms in pension matters relates to the freedom of access to amounts saved up for retirement. Changes in the pension freedom purpose to grant individuals greater power over the spending, saving, and investment of their retirement pots. Among the key changes is the provision that will see people aged above 55 years gain access to their entire pension savings. Under the previous system, such individuals had limited access to these funds.
This change is important to both the working individuals who are considering how to save and the retirees considering the best use of their pension savings. One of the most obvious effects that this change has is the reduction in the purchase of annuities. Since an individual will have access to all their money, it will be unnecessary for him or her to purchase an annuity that will provide income for them until they die. Hence, it is likely that more people, especially those already retired, will shy away from annuities in favor of other investment opportunities.
With the easier access to funds for individuals comes a greater risk of investment failure. Many people are likely to use to use the greater access they have to pension funds to go on holidays, purchase new cars, or improve their homes. Engagement in such activities means that people are more likely to lose their money. Since such activities are not worthwhile investments, it means that the retirees will be at a greater risk of burning through all the amounts saved. Consequently, they may end up running out of money before they die. Other individuals may also use the money to clear debts such as mortgages hence depleting the amounts.
Instead of purchasing an annuity, people will have the alternative of keeping their pension invested and drawing on it according to their needs. They will also be allowed to cash in the whole amount if they so wish. Whereas the option of keeping funds invested was available even in the past, only the drawdown system was usable during the withdrawal of funds. Annuities at present provide poor investment value for individuals because of the poor rates offered. These poor rates are the result of economic trends such as low growth, which affect the interest rates. Government policies such as quantitative easing also play a role in the low rates, as does the increased life expectancy.
This drawdown system, however, had restrictive rules on how much one could withdraw if they lacked a certain secure income from other sources. According to the changes, one can withdraw up to 25% of the amount tax-free. This withdrawal may be done as either a single lump sum or several lump sums. In case of several withdrawals, the first 25% of each withdrawal will be tax-exempt. The change means that individuals who are
considering how to invest their pension money are likely to leave it in their pension pot. The reason for this is that the money will be growing and accruing interest while they withdraw only what is necessary.
Another change introduced in the auto enrolment requirement for pension schemes. Automatic enrolment refers to a government initiative aimed at aiding a greater number of people to save for their later life. The government does this by making it mandatory for all employers to offer a workplace pension to all the eligible workers. The automatic enrollment into the system is for all the employees who qualify. The employer is also required to make a minimum contribution to this scheme. The individual employee also contributes to the scheme and relief is allowable on such contributions. To ensure flexibility, an individual may leave the scheme at any time they so wish.
Auto enrollment is likely to affect individuals who are in the working age the most. Working class individuals who are considering the best way to save for their retirement are likely to see this as a very attractive option. The attractiveness of this option lies in the existence of the employer contributions and the tax relief for the contributions made. For these schemes, the earlier one begins saving, the better for them; hence, younger workers are likely to gain motivation to save.
Another change that the government has instituted is the relaxation of inheritance tax penalties. In the past, a 55% tax was chargeable on any amounts in invest and drawdown schemes that were inherited by children. The reforms, however, eliminate this tax, and this affects retired people who are assessing how to use their pension savings upon retirement.
Retired individuals are highly likely to take advantage of these new rules through saving more money in pension pots. The individuals are also likely to strive harder to preserve the amounts already saved up. Some of the specific measures they may employ include moving into smaller sized homes to release funds as opposed to tapping into pension savings. Individuals may also be likely to transfer money from other sources or investment schemes into pension pots. The reason for this is that the removal of tax makes pension pots the most attractive way of transferring their wealth to the younger generation.
Another change relating to the pension laws relates to the eligibility for a state pension. State pension refers to a regular income provided to an individual by the government after the attainment of the retirement age. Individuals make a limited contribution to this pension through their contributions to national insurance. Besides this basic pay, a top-up pension exists for individuals who qualify. Any person who has attained the state pension age may access this second state pension. According to the terms of the new system, the basic and top-up pensions are merged into one single-tier pension, which will be available to people with a minimum of 35 years of contributions to national insurance.
The new system promotes equality through the elimination of the current regulations under which pensions given to women are lower than those given to men. The introduction of the single-tier system means that individuals are now capable of determining how much money they are entitled to receive from the government. Hence, this will aid them in planning of their retirement savings. Once an individual has knowledge of the specific amount that he or she expects to obtain, he or she can evaluate investments that will provide a steady flow of income for the rest of their lives.
Hence, with the introduction of these reforms that promote freedom of access to pension funds, the risk of workers making poor investment decisions increase a great deal. Poor investments would mean that the individuals lose their hard-earned pensions and lack a stable income in their future lives.
In planning for how to deal with clients, it is thus imperative to provide training on the advantages and disadvantages of certain investments. The only way to do this is by having an understanding of how the changes to the pension regulations affect the individuals. For instance, one can explain to the client that the changes mean that he or she can withdraw the total pension amount whenever he or she wishes. One may also explain to the client that it is not mandatory to invest funds in annuities. The advisor should explain to the client that investment in these annuities might not be the best use of their money because they may not guarantee a stable income for the rest of the client’s life. The auto enrollment provision is another area of importance to the client and in this the area, the client must know that as an employee, he or she should belong to them. The earlier one registers for them, the better, and it is also a good way method of wealth transfer for future generations.
Banks, J. & Emmerson, C., 2000. Public and Private Pension Spending: Principles, Practice and the Need for Reform. Fiscal Studies, 21(1), p. 1–63.
Crawford, R., Keynes, S. & Tetlow, G., 2013. A Single-Tier Pension: What Does It Really Mean?, London: The Institute for Fiscal Studies.
Ginna, J. & MacIntyre, K., 2013. UK Pension Reforms: Is Gender Still an Issue?. Social Policy and Society, 12(1), pp. 91-103.
Harrison, D. & Blake, D., 2014. The Future of Retirement Income: Retirement income after the 2014 Budget, London: Which?.
ILC–UK, 2014. Challenges in the new world of pensions, London: International Longevity Centre-UK.
Jefferies, T., 2014. Whether you're saving for old age, about to retire or already have - here's why you need to give your pension some attention in 2015. [Online] Available at: http://www.thisismoney.co.uk/money/pensions/article-2890203/What-need-know-pensions-2015.html[Accessed 8 July 2015].
Jefferies, T., 2015. One in three savers plan to leave a bigger inheritance by boosting their pension pots thanks to new freedoms. [Online] Available at: http://www.thisismoney.co.uk/money/pensions/article-3146144/Savers-stashing-pension-pots-bequeath-loved-ones.html[Accessed 8 July 2015].
Jefferies, T., 2015. Will you receive more government cash towards your retirement? The ten big pension changes Osborne could make in his summer Budget. [Online] Available at: http://www.thisismoney.co.uk/money/pensions/article-3152041/What-big-pension-changes-Osborne-make-summer-Budget.html#comments[Accessed 8 July 2015].
Lambert, S., 2014. The three big pension freedom changes you need to know about. [Online] Available at: http://www.thisismoney.co.uk/money/pensions/article-2792180/savers-25-tax-free-multiple-pension-lump-sums-three-big-pension-changes-need-know-about.html[Accessed 8 July 2015].
Meyer, H., 2014. What the changes to pension rules mean for you. [Online] Available at: http://www.theguardian.com/money/2014/mar/27/changes-pensions-mean-to-you[Accessed 8 July 2015].
Thornton, P. & Fleming, D., 2011. Good Governance for Pension Schemes. 1st ed. Cambridge : Cambridge University Press.
Webb, C. et al., 2008. Individuals' attitudes and likely reactions to the workplace pension reforms 2007: Report of a quantitative survey, London: Department for Work & Pensions.