The question is, when we look back at the Chancellor’s 2014 Budget, with the benefit of a 20 year perspective, will the reforms George Osborne has proposed have resulted in more people being better prepared for retirement?
Happily there have been one or two controlled experiments: Australia, Chile, Singapore, Switzerland for example, which give us some pointers as to what we can expect. Unhappily the outcomes are not universally positive. Experience in the Australian market, for example, should leave us less than optimistic. In advocating the proposed reforms, George Osborne alleged that the system he envisages “works in Australia”. The evidence suggests that this is not entirely the case. In a market where saving is compulsory but there is no need to convert savings into an annuity, there is a growing concern that an increasing proportion of the population will outlive their savings by some distance. The consequence of this is, of course, that the demand on the state provision will increase.
In many ways the Chancellor’s Budget, while not at all conservative, is extremely Tory. Everything we have understood about our retirement options is being disbanded and a huge reliance placed on individual responsibility. A glance at the evolution of the defined benefit pensions market suggests that depending on the rational, well informed decisions of individuals to ensure that collectively we have adequate pension provision is likely to yield an unhappy outcome. Fastidious and prudent boards of trustees, overseen by qualified finance directors and advised by appointed actuaries, have failed to ensure adequate funding for an enormous portion of occupational pension schemes. There has been a systematic underestimation of life expectancy and a habitual overestimation of investment returns. While allowing only modest deficits to be reported, this has resulted in significant underfunding.
To expect an individual to be able to more reliably complete these estimates and to resist the tantalising opportunity of spending ‘savings for retirement’ on ticking off a bucket list shows an endearing confidence in the probity of the majority of the population or a complete failure to grasp the fundamentals of behavioural economics.
The Chancellor has attempted to mitigate this risk. At the centre of the proposals, the new safety net is what looks like the introduction of a National Wealth Service. The Chancellor has visualised a network of selfless individuals proffering generic guidance to the uninitiated in the mysteries of longevity tables and compound interest. The government has set aside £20 million in the form of a development fund to create the models for the guidance required to ensure prospective pensioners are properly informed. These will need to be up and running well before April of next year.
However, while in the long term pessimism seems easy to justify, the short term consequences of these reforms are immensely attractive. This has nothing to do with the structure of the pensions market and everything to do with macro-economics. The unwinding of quantitative easing will suppress real interest rates for some time to come. Providing a practical option for pensioners in the form of a drawdown of a portion of the capital saved to create a retirement fund obviates the need to commit to an unattractive long term interest rate. Best advice has been, for several years now, to put off the purchase of an annuity if this can possibly be afforded. The new drawdown concession means a far greater number of people will be able to do just this. Correspondingly share prices of annuity providers have collapsed.
The minimum pension required to unlock the drawdown option is set at 40 per cent of the national average household income. This is much less than the old two thirds of final salary promise made by traditional DB schemes.
Collectively the Budget proposals look to be far more concessions to accommodate an unattractive interest rate environment for a generation of savers already caught by the transition between defined benefit and defined contribution than a solid foundation for long term retirement funding. In the short term the tax take will rise as will consumer spending; in the long run the state will pay.
Mark Wood is Chief Executive, JLT Employee Benefits