Freedom and choice in pensions Buck Consultants response to Treasury Consultation

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1 Freedom and choice in pensions Buck Consultants response to Treasury Consultation June 2014

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3 2014 Xerox Corporation and Buck Consultants, LLC. All rights reserved. Xerox and Xerox and Design are trademarks of Xerox Corporation in the United States and/or other countries. Buck Consultants is a registered trademark of Buck Consultants, LLC in the United States and/or other countries. BRP2825. Other company trademarks are also acknowledged. Document Version: 1.0 (July 2014).

4 Introduction We are pleased to have this opportunity to respond to the consultation on the proposals for a new structure for retirement benefits from workplace pension schemes announced in the Budget in March In principle we support the proposed approach. It is no secret that the present options in retirement available to a member of a defined contribution (DC) workplace pension arrangement are not in practice giving good outcomes in many cases. Although there is no obligation in principle upon a member to purchase a lifetime annuity from an insurance company, the circumstances surrounding the decumulation from a DC scheme are such that in practice for almost all members that is the only route available. For many that is the best route, giving a secure, predictable income for life, but it is by no means the case for all particularly those whose accrued DC funds are so small that the charges become disproportionate, which is a problem that many face today, but which hopefully will diminish over time if contribution levels can be improved. Furthermore, with such a strong bias towards annuity policy purchase, there is a clear danger that what should be an open and competitive market in such policies becomes less efficient than it could or should be. We therefore support giving members greater freedom in practice to choose alternatives to the purchase of a lifetime annuity, if that is more appropriate for them. However, there are three key issues to address: With this new freedom comes responsibility. Our experience with designing and running workplace pension arrangements for our clients in the UK and overseas matches that of others in that it is often extremely difficult to engage individual members sufficiently with their pension arrangements for them to be able to identify and take appropriate decisions. It also follows that such members are at increased risk of being guided towards an inappropriate route. Therefore the proposed new freedoms must be accompanied by effective information and assistance, and balanced with appropriate safeguards. The proposed new freedoms are predicated on the assumption that individuals will accrue the new state basic pension in full. However, not everyone will be able to accrue the new pension in full. We recommend that the government considers whether it nevertheless wants these people to have access to the proposed freedoms. The new drawdown system must be affordable. One of the drivers of this reform is the perceived poor value of purchased annuities, so any successor must be an improvement if it is to be worth expending the effort on. Since a substantial part of the cost of running the current drawdown system is due to having to comply with the regulatory requirements, their significant simplification should remove many of those cost pressures. We also support the stated intention of reviewing (downwards) the tax charges around death benefits from residual pension funds held under schemes. If funds are not to be used to purchase an annuity, then in order to avoid undermining the new flexibilities, the tax treatment of funds (if any) remaining at death should be equitable, and not punitive as they are under the current tax regime. Buck Consultants response to Treasury consultation 2

5 Retirement benefits schemes are for retirement There is one further general point, which we consider to be of great importance. It has become customary in recent years with the wholesale movement away from defined benefit schemes towards defined contribution to talk of pension schemes as savings schemes. Whilst that is accurate in the sense that members save money into them, which is then invested to provide benefits later, it can mislead by being confused with a true savings scheme, such as an ISA. It is important that a pension scheme is focused upon providing benefits to members during their retirement. In the current environment it is right that provision comes with flexibilities to fit a member s individual needs and circumstances, but there should be restrictions to ensure the focus on retirement benefits. A key contributor to that focus is a system of tax relief that encourages and underpins the deferral of consumption that saving for retirement involves. In the UK the tax relief also represents a contribution by the state towards private provision made by those who are prepared to help themselves by supplementing their state pension. The introduction of automatic enrolment does not change this basic principle. Tax relief has been progressively reduced over many years and particularly so during the course of the current parliament. This has encouraged those voices who call for a further reduction and restructuring of the tax relief system for retirement benefits. However, to follow those voices would undermine the crucial support aspect of retirement provision the need to compensate for the deferral of consumption of resources over many decades. This fundamental principle marks retirement provision out from any other kind of consumption deferral, and so requires focused policies. We are aware that in some quarters the new flexibilities proposed in the consultation document will be (mis)taken as a step towards removing the special focus on retirement provision, and putting retirement schemes on a level playing field with other savings schemes. To do this would be a mistake. We would therefore urge the government to reiterate clearly the special nature of funded retirement provision and its distinction from ordinary savings schemes, and to reflect that position in its future treatment of tax relief for retirement benefits. 3 Buck Consultants response to Treasury consultation

6 Reponses to the consultation questions 1. Should a statutory override be put in place to ensure that pension scheme rules do not prevent individuals from taking advantage of increased flexibility? Yes. Although as a matter of principle employers and scheme managers should have freedom to construct scheme designs that suit their purposes, there is a further fundamental principle that the new flexibility should be available to all members of all schemes, on a level playing field basis. If it were left to individual schemes to interpret the flexibility and reflect it in their rules, the practical outcomes for members may differ and in extreme cases scheme managers could decide not to offer increased flexibility. However, this does not mean that the detail of the options should be incorporated into legislation, nor that the legislation should impose any positive requirements or duties upon schemes. For example therefore legislation should not require all schemes to offer a drawdown facility within their scheme (as opposed to allowing a transfer of a member s accrued funds to another product, whether held under the scheme or outside it). Many schemes will not have the capability to provide such facilities inhouse, and imposing such a requirement upon them would inevitably increase their costs. 2. How could the government design the new system such that it enables innovation in the retirement income market? One underlying principle to be followed is that, as the question intimates, the design of the new system should enable innovation. That means the government should resist any urge to build into the design of the system any prescriptive requirements, or any attempt to direct or encourage any particular direction for scheme design to follow. It should be left to the market to innovate, with the government s role restricted to: establishing in broad terms the outcome it wants to see achieved, taking into account such things as social, economic, demographic and moral issues, both for individual members and for the state as a whole setting out the broad parameters within which scheme designs should fit creating a proportionate regulatory system to protect members benefits that accrue within the new retirement provision system, and ensuring that the regulatory system is effectively enforced. Buck Consultants response to Treasury consultation 4

7 In all of this the sponsoring employer s position should also be borne in mind. Although automatic enrolment provides a minimum level of benefit for all, that level is broadly insufficient to meet most members needs and certainly their expectations. A well-designed scheme will encourage member engagement and employer support, increasing the chances of higher than minimum contributions being paid. Stability: When all these things have been done, the whole system should then be left alone for a number of years, to settle down and to enable the market to develop. There should be periodic reviews (perhaps one per parliament at most) by a reconstituted Pensions Commission, containing representation from across government departments affected and from across the political spectrum represented in that parliament. The Commission should be a permanent body, with a general remit to assess the suitability of the system, with a statutory duty to conduct a formal review every 5 years. This stability would be a key feature, building the confidence amongst members to engage and make suitable contributions to their scheme, and encouraging commercial players in the pensions market to commit the capital investment required to develop and market the new innovative products that the government is seeking. Taxation: A key issue will be the taxation treatment of workplace pensions. It has long been the case in the UK that the state has seen private pension provision as a positive, and encouraged it through a system of tax reliefs. More recently however, the commitment to use the taxation system in this way has waned. We believe that this change is partly to blame for the decline in private workplace pension provision over the period. There appears still to be an appetite not only for reorganising the tax relief system, but also the overall amount of relief given. In the introduction to this paper we explain why in our view it would be wrong to continue down the path of changing pension tax reliefs. Protection: Another important consideration that should be on the government s list is the balance between the protection of the member s accrued funds and the protection of those managing the scheme from frivolous or otherwise inappropriate claims from members. It is well known that the overall level of knowledge and understanding of financial matters amongst the general public is poor, and countless surveys have indicated that most require expert assistance with pension matters. With the proposed increase in choice, the need for such assistance will only increase. The proposals for the provision of guidance for all members may help some, but a large proportion of the population is still likely to be accruing and receiving workplace funded retirement benefits for many decades, without having fully understood or engaged in the process. Many of those will be looking for someone else to organise and run their pensions for them, and in the process to take decisions on their behalf when options arise. This will present a significant challenge to the success of the future system, and is something that must be addressed. We anticipate that a likely innovation will be a growth in the management of members pension affairs, with the extreme being a default process that takes all decisions from the hands of a member, throughout the whole period of membership including the decumulation phase. This will be essential to avoid arrangements stalling for millions of members who will not take decisions, or if pushed into action, will simply agree to the option that is the easiest to select. Those responsible for running schemes and therefore taking the decisions from time to time could be vulnerable to future claims from members with a poor level of understanding, whose retirement finance expectations (even if those expectations are 5 Buck Consultants response to Treasury consultation

8 unrealistic) are not met. One key design aspect of a new system therefore is some form of statutory protection or safe harbour arrangement to protect the reasonable process implemented and decisions taken by those managing schemes. Any system of provision will need to be paid for. Some of the overall costs will effectively be covered through a contribution from the state through the system of tax relief. At the end of the day, a decision will have to be taken as to who will bear the balance of the costs, and the guiding principle should be that the party that benefits should also bear the related cost. On that basis the majority of the additional cost should ultimately be borne by the member and there should be total transparency over how it is calculated and levied. One important specific potential innovation, as the consultation paper identifies, is the possibility of utilising some of the funds accrued to the member under the pension scheme to purchase healthcare insurance or some form of health-linked annuity which would require changes to the tax laws. This may not be a realistic option for most members of DC schemes at the moment with the current levels of funding, but if the tax laws were to be changed to encourage the development of new healthcare products, it should provide an additional impetus for members to contribute more to their schemes, as it would underline the usefulness of deferring consumption during the working years. 3. Do you agree that the age at which private pension wealth can be accessed should rise alongside the State Pension age? Yes. Our comments in the introduction of this response in respect of tax relief, explained the importance of pension provision remaining distinct from other forms of savings. For the same reasons access to retirement funds should be related broadly to retirement needs - broadly because the concept of retirement itself is undergoing change with consequent need for a more flexible system in response. It follows therefore that, whilst allowing for a degree of flexibility, there should be some correlation between the earliest date from which private pension wealth can be accessed and that from which the right to claim state pension commences. An important part of the role of private pensions particularly in the current environment of more flexible employment and retirement patterns is to provide the option of a bridge between cessation of full employment and retirement if a member needs income during that period. In the light of our arguments on the special nature of pensions, together with the limited funds that may be accruing at the moment, the link to State Pension age (SPA) makes sense. However, this principle needs to be qualified in three ways: The transition of SPA to higher ages is planned to occur in multiple short, monthly, steps. Tracking those exactly would be a costly administrative burden upon workplace schemes. We therefore suggest that, although the tracking should be broadly aligned, the increases in the minimum age for the scheme s benefit should be done through fewer steps preferably annual adjustment SPA is currently undergoing a period of two sets of changes to equalise between the sexes and to increase in response to improving average longevity which makes the adjustments more severe than they will be in the future when only longevity-related changes will be made. Given that the options around workplace pension benefits are complex and require detailed and careful Buck Consultants response to Treasury consultation 6

9 planning, changes to the regime affecting them need to be made with a reasonable amount of notice. Therefore we suggest that, although the earliest pension benefits access age should broadly track SPA, the first increase from 55 should be delayed for at least 5 years, at which point the age would jump to being 10 years behind SPA, and thereafter broadly track it When the benefits access age is increased, transitional protection should be available so that individuals do not incur a Lifetime Allowance charge as a result as was the case in 2006 when the age was increased to Should the change in the minimum pension age be applied to all pension schemes which qualify for tax relief? Yes; there should be a level playing field for key metrics across all tax-relieved pension schemes, as part of the process of breaking down the old rigid distinctions between types of schemes. 5. Should the minimum pension age be increased further, for example so that it is five years below State Pension age? No. See our answer to question 3 above. 6. Is the prescription of standards enough to ensure the impartiality of guidance delivered by the pension provider? Should pension providers be required to outsource delivery of independent guidance to a trusted third party? In principle the prescription of standards, monitored and enforced if necessary by a compliance regime, should be sufficient to ensure the impartiality of guidance delivered by a pension provider. However, although much of the basis of this still has to be settled, it appears that the guidance in question is intended to be of a generic nature, which means that it will have to cover all potential options available to the member, and not just the type(s) of solutions that can be delivered by the provider. Although reputable providers should be more than capable of delivering quality guidance that satisfies the required criteria, others may struggle. The guiding principle is that guidance should not be given by anyone who could stand to gain from a decision made by the person receiving the guidance. However, from a member perspective, the perception of independence behind the guidance may be stronger if it is delivered by an organisation that does not also offer products or services that fall into one of the categories that the guidance may cover. For this reason we feel on balance that the statutorily-required guidance should not be delivered directly by a provider. The criterion for independence could be met by a commercial organisation, funded by the government. 7 Buck Consultants response to Treasury consultation

10 7. Should there be any difference between the requirements to offer guidance placed on contract-based pension providers and trust-based pension schemes? Individuals rarely have any input into the type of arrangement that is selected to provide their workplace retirement benefits, but the decision should not of itself result in any difference of outcome for the member. Consequently, the overriding principle should be that the standard and type of guidance made available to a member should not differ according to whether the underlying legal basis is trust or contract or indeed any other basis that might be used in the future. This suggests a form of centrally-provided guidance, either delivered or accredited by a third party that is independent of other parties involved in retirement provision. Since the proposed guidance is generic and envisaged to be the first stage of a twostage process where the selection and purchase of a particular product (if any) does not occur until the second stage, the level and extent of regulation of first stage guidance providers will not need to be as strict as that for those involved in the second stage. This is important not only to encourage competent parties to enter into the first stage guidance market, but also to control costs. It would be easy to over-engineer the first stage guidance, in an understandable desire to provide high quality assistance to members, supporting the objectives behind automatic enrolment. However, with the estimated numbers of retiring members annually expected to be well in excess of half a million, the potential demand for the service around retirement date alone points to the need for substantial resources to be made available, which calls for a proportionate approach to the regulatory oversight of the service. There is also an issue over who will be bear the costs of providing the guidance. One of the government s criteria for this guidance is that it is free to the consumer. It is difficult to see how, in the context of a contract-based arrangement, this cost can be borne through the product by any party other than the member. If the provider is required to carry the cost, it will be impossible to prevent the cost effectively working through to the member. In a trust-based scheme, the trustees will not usually have an unallocated fund to cover the cost of providing guidance. In that case the only funds they have will be those in members pots. It would be possible in principle to impose the cost upon employers, but again it is likely that that will ultimately impact upon members, either through their pension arrangements or through another aspect of their remuneration packages. A further issue is that there would be a discrepancy between contract-based arrangements for employees and those for the self-employed, both of whom would be utilising similar products to provide for their retirement. It is clear there will be a cost for the service, which should be available to all. The most appropriate approach will therefore be to accept that the member will pay for it one way or another and since it potentially benefits everyone in the country, it should be funded centrally, through the collection of a (small) levy from all employees and the self-employed through the NI contributions system. Buck Consultants response to Treasury consultation 8

11 8. What more can be done to ensure that guidance is available at key decision points during retirement? The consultation paper is right to identify the need for help and support to be available to members of DC schemes at points when they are faced with the need to take decisions. With the new options proposed for the retirement phase, the decision points increase in number considerably and may effectively arise annually where a member takes full control themselves of the drawdown option. But, the complexity of the decisions that need to be taken and the individual nature of those decisions, dependent upon the member s particular circumstances, mean that it is difficult to identify accurately in advance when all of the decision points might arise. Although there will be particular predictable key points, the dates at which they will arise will be difficult to predict as they will be dependent upon choices made by the member during their period of scheme membership; at any time during that period they could take a decision that would change their future employment and retirement timetable and so change the dates of future key decisions. There could be any number of key decision points, including: joining investment strategy reviews just before the earliest possible retirement date the start of any lifestyling years from anticipated commencement of retirement (and if retirement is to be taken up gradually, at appropriate dates before each possible tranche of retirement benefit is taken) discovery of a serious medical condition births/marriages/deaths This illustrates that in order to take full advantage of the flexibilities offered by the DC regime a member needs to be fully engaged in their scheme throughout, which requires continual access to relevant information and in most cases at least informed guidance. Currently it is possible for a scheme to restrict options or provide default packages that effectively take a number of these decisions automatically on behalf of the member, in which case after the initial decision (or absence of one) resulting in taking up the default option, the guidance requirement arguably becomes less important, and can be restricted to fewer occasions. However, the implication in the consultation paper that the guidance envisaged in respect of the proposed new retirement options can be delivered on one occasion, at which the member will take decisions on all aspects of their retirement planning, is not credible even if the expected outcome in most cases is that the member will choose to select a packaged solution, as the consultation paper seems to envisage. The ideal solution therefore would be to encourage at least some basic level of member engagement and provide guidance at an appropriate level throughout. This can be an expensive proposition, but does not have to be. We have experience of situations where one or two key individuals in a company (probably under the HR function) undertake regular informal discussions with groups of employees on pensions matters, thereby building a pensions culture. Then, when specific occasions 9 Buck Consultants response to Treasury consultation

12 arise where individuals have to take a decision that requires formal professional (paid for) advice, the advice can be focused and kept to a minimum. If the conclusion is that a more widespread guidance system is to be required, we see a role for the government in sponsoring the production by specialist institutions that are independent (including of the government), of generic information and other materials to complement the more targeted contributions from trustees/employers/providers and their advisers. 9. Should the government continue to allow private sector defined benefit to defined contribution transfers and if so, in which circumstances? Yes. We would like to see wherever possible a level playing field across all types of retirement benefits provision, and the removal of arbitrary distinctions between defined benefit (DB) and DC and trust-based and contract-based wherever possible, whilst maintaining (as mentioned above) the crucial distinction between funding for retirement benefits and general savings. The barriers between DB and DC are in any case likely to be lowered by the forthcoming defined ambition (DA) proposals which we consider to be a helpful development. If the ability to transfer from the DB regime to the DC one were to be withdrawn as a result of these proposals to offer considerable additional flexibility to DC members, that would undermine the DA proposals. The government s stated intention is to introduce new statutory definitions of DB, DC and DA arrangements, and this would raise issues and complications around whether transfers could be made from DB schemes to DA and if so to which specific designs. Such an approach would conflict with the principle of ensuring that such legislation does not introduce restrictions that effectively dictate available scheme designs by preventing future new ones from emerging (as explained in our answer to question 2 above). There is one restriction that is increasingly becoming an anachronism in this new world of flexible retirement options the limiting of a member s statutory right to a transfer, to the period up to one year before the scheme s normal pension age. This restriction should now be abolished. 10. How should the government assess the risks associated with allowing members of private sector defined benefit schemes to transfer to defined contribution under the proposed tax system? There are two main areas of risk in allowing such transfers: the risk to members of giving up the protections of the DB regime, and the risk to the wider economy. The risk to members: Members would be giving up valuable protections by switching to the DC regime and so should only do so as an informed decision. We believe that members today generally have a better understanding of the key benefits of a DB benefit, and many value those. We understand that there has been a decline in numbers taking up enhanced transfer offers and pension increase exchanges since the industry code was introduced, which suggests that members appreciate the value of a DB promise when they understand it. Buck Consultants response to Treasury consultation 10

13 On the other hand, there will undoubtedly be people who will value more the new flexibilities and options proposed under the new DC arrangements. That should be their decision, provided that they are properly informed. If we think it is appropriate to allow those who have built up their retirement benefits in a DC regime to have the new flexibilities, then we should not arbitrarily prevent those in the DB regime access to those same flexibilities. The risk to the wider economy: There is a legitimate concern that if there is a widespread transfer of assets out of DB schemes and into DC ones (and from there possibly out of the system altogether through the exercise of drawdown), then there will be less money available for investment in government and corporate bonds, which are the asset bedrock of a mature DB scheme with accrued pension liabilities to cover. However, the money released into cash would be circulated around the economy in other ways, and where it was spent, would generate immediate tax revenue for the government, providing some counter to the loss of investment money for gilts, and boosting corporate revenues in the round. There is no precedent in the UK for a change of rules in the pensions area along the lines proposed, and so it is impossible to predict what will happen in practice. On a simplistic level we consider that whether or not there are major shifts in the way in which retirement funds are used, the overall effect for the government will be largely neutral. Therefore we do not consider that it needs to be a major concern for the government to assess for the purposes of this exercise. 11 Buck Consultants response to Treasury consultation

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