Pensioners aren’t the problem – the pensions industry is

It is time for the hysteria to end. George Osborne’s changes to the UK’s pension system do not herald the beginning of an era in which all pensioners will spend the early years of retirement driving mid-engined Italian supercars between their many holiday homes, and their later years begging for stale sandwiches outside Starbucks.

The idea that, given the freedom to do so, our over-55s will take their entire pension in one lump and spend it is ridiculous. I know this because they don’t do so now. Anyone who wants to can take all their pension at 55 in a lump sum. They just have to pay 55% of it in tax for the privilege.

The new system is for practical purposes little more than a reduction in the 55% to about 45%. You have to pay income tax on anything you take out of your pension at your marginal income tax rate – so if you have £500,000 and you take it all out at once, you will find you are well into 45% land.

So, given that the vast majority of the UK population is sentient and rational – I insist on believing this – the real risk here isn’t that people will take all their money out*. Nor is it that people will leave their money in their pension but spend too much on an annual basis, so ending up with nothing at the end.

If anything, I suspect the opposite. Imagine retiring after years of saving the money you think you need to last you 30 years-plus. You aren’t buying an annuity so you know there are no income guarantees. What are you going to do? Turn the heating up and book a Caribbean cruise?

My guess is that most people will err on the side of caution and underspend: who will want the cruise more than they want to be able to pay the premium for proper nursing care?

No, the real risk isn’t the greed and incompetence of pensioners, it’s the greed and incompetence of the British financial services industry.

I’ve often written about the venality of much of the industry. The overcharging; the gratuitous complications; the faux intellectual language used to create pointless specialisms out of simple activities; the churning; the intelligence wasted on regulatory capture; the general failure of the average money manager to live up to even the most meagre of long-term promises.

It is partly down to the shockingly awful value offered by annuity providers that George Osborne started down the path to pension reform in the first place.

But here’s the problem: if we are all going to go annuity-free, we need the financial industry to raise its game to create the products that will make the new system work. We might need funds that split returns by type – paying all the capital gains to savers who aren’t yet retired, and all the income to those who are.

Or perhaps funds that don’t pay out actual returns every year, but smooth out gains to offer a consistent return that rises with inflation. Or perhaps just large diversified funds that can pay out capital as income to make returns consistent over several decades.

More than 400,000 people are expected to benefit from major changes to pension rules coming into force, which will allow savers to unlock thousands of pounds more cash from their retirement funds

Anyone who has been knocking around in the financial industry for a while will see where I am going here. We need new versions of old concepts, such as split-capital investment trusts, with-profits funds and investment-linked or low-priced annuities – versions that don’t rip us off and blow up, but which find a balance between the use of capital and income that gives us a feeling of long-term security.

We’ll need to move beyond investments listed on standard exchanges. Modern pension funds tend to be obsessed with liquidity, but given the long timescale of pension saving, this isn’t really that big a deal.

I want to make 7% a year on my money both while I’m saving and later when I am spending, so over a good 60 years. That means it makes sense for retirees managing their own futures to look for unlisted, but high-yielding investments outside the overpriced FTSE 100.

I wrote about forestry a few weeks ago. But clever fund managers will be looking to launch funds that recreate the long-term returns available from lending to medium-sized companies. In a couple of weeks, a well-backed new crowdfunding firm called Money & Co will launch. Those lending through it can expect returns in the high single-digits. Pension savers should be getting those returns too.

Outside that, there must be opportunities to securitise various long-term income streams (as once was the case with pharmaceutical royalties and Canada’s oil royalties) or for large diversified retail funds to get into energy and infrastructure project finance directly.

As one finance director put it to me this week: “Why do pension investors only get access to low-dividend or bond-like yields from corporates, when the same corporates would never consider a project without an internal rate of return many times higher?”

There’s soon going to be a lot of money knocking around – money that once went into annuities – looking for very long-term, relatively high-return investments. That represents a fabulous opportunity for fund and wealth managers as well as the government, which could set up a state-managed ‘Domestic Infrastructure Income Plus Fund’ to harvest such money.

It is good for journalists too, because the real risk here is that our financial industry will create new products to fill the gap, but that those new products will come with all the problems of the old ones. Bad for consumers, but it means we are never going to be short of subjects for critical columns. In that sense, this Budget really is going to be the gift that keeps on giving!

*I did an online poll last week just to be sure: 71% of people said they had no intention of taking out more than their tax-free 25%.

• This article was first published in the Financial Times.

  • Bus Passes website

    Under the new arrangements if a pensioner wished to invest his pension ‘pot’ rather than buy an annuity, would this be taxed in the way you describe in this article? I understand that the Australian system wouldn’t.

  • Haddock

    Where does Merryn get the figure “400,000 people” expected to benefit from the new rules ? And in what time-frame ? Surely the benefit applies to anyone not yet retired in UK, ongoing. Has anyone put a figure on how much money which would have gone into conventional annuities and which may now be annually channelled into other investment forms e.g. buy-to-let, equities, or the other putative vehicles which Merryn briefly discusses ? If this figure is something in the billions then it could have a substantial impact on the pricing of all these and create a very different financial geography perhaps.

  • Ralph

    Pensions have always been taxed as earned income and as far as I am aware that is still going to be the case going forwards. This being the case the split between income and capital is irrelevant. Equity income inside a pension fund is taxed at 10% but yield stocks still remain a very useful asset class for retired people, as is often covered in MW. The industry therefore doesn’t need any new investment vehicles at all in my opinon. The wide prolification of funds that already exists is enough of a headache for most people, without adding to the number. If you want to separate your income and capital accounts, then a decent SIPP provider can do this for you but if, as you say, most pensioners err towards caution, then this is potentially a risky strategy if you intend to take both sums as pension. Having said that, I do feel there is a rational argument for taking more from your pension pot in the earlier years, as most people find that the older they get the less they spend (or so they tell me :0)).