Should we be worried about the Australian experience of pension freedoms?
In recent months it has become received wisdom that the chancellor of the exchequer’s reforms to pensions – the most significant for more than a generation – form a long-overdue liberalisation of an annuitisation regime that was better suited to a bygone age.
In today’s era of low gilt yields and long lifespans, it is much harder to argue that people should be prevented from putting some of their retirement money to work outside of annuities.
Yet before ditching those low-yielding annuities once and for all, it is worth considering the experience of Australia, where policy is currently heading in precisely the opposite direction.
Twenty years ago, the Australian government revolutionised the country’s pensions system, turning it from a regime that compelled individual retirees to buy annuities to one that gave them far more choice over where to put their pension money – and when to take it out.
Today, roughly half of all new retirees in Australia take out their pension as a lump sum. As many as 44% then use the money to pay off household debt, purchase a home or make home improvements. A further 28% use the money to repay vehicle or holiday loans, or simply to buy a new holiday or new car. Most concerning of all is that a quarter of those who take their pensions as lump sums exhaust their funds by the age of 70.1
A population that is increasingly burning through its cash and falling back on the state has alarmed the Australian government sufficiently for it to commission a report into finding a better blueprint. The Murray Inquiry calls for changes to ensure people are channelled towards securing a regular income stream rather than defaulting to a bank account system for drawing a pension. It also encourages the development of retirement income products with pooled longevity risk protection, and proposes the removal of tax and other barriers to foster the advance of annuity-like products.
But it doesn’t go as far as endorsing some form of compulsory annuitisation. It is arguable, therefore, whether the report’s recommendations will ensure that a crisis can be totally averted.
Back home, traditional UK government policy favoured annuities on the basis that they provided a guaranteed fixed income for life, irrespective of lifespan, and were insulated from many of the usual investment risks.
In fact, the British government did begin to change policy after gilt yields nose-dived in the 1980s and 1990s. New ‘income drawdown’ alternatives introduced in 1995 gave individuals the right to draw a flexible income from their pension fund and to keep it invested beyond the point of retirement. Following the reform, income drawdown started to gain momentum, and over the decade that followed, annuities lost some of their stranglehold.
Nevertheless, annuities remained the default choice for most in retirement. Furthermore, the rules virtually forced retirees to buy an annuity if the value of their pension did not meet the criteria for income drawdown, or if they were over the age of 75. Successive chancellors gradually removed more and more controls – the requirement to buy an annuity at age 75 was removed in 2011. But annuity sales remained dominant.
However, with ‘pension freedoms’ launched in April 2015, Chancellor George Osborne has all but rejected the idea of purchasing an annuity. Everyone, regardless of their age or the size of their fund, now has the liberty to manage their own investments and to draw income or lump sums however they like, without the restrictions that once applied. The result is that the annuity is in major decline in the UK.
According to the latest figures from the Association of British Insurers, in the first two months following pension freedoms, savers put in £630 million to buy 11,300 annuities. This compares to nearly £1.2 billion a month in sales of annuities at their peak in 2012. Over the same period, savers took out over £1 billion in 65,000 cash lump sums from their pension pots and put £720 million into 10,300 income drawdown policies.2
Aussie back row
Thus, just as the UK moves towards a more liberal approach, Australia is considering rowing back in the opposite direction, tilting the system to favour those retirees who purchase income products that help manage longevity.
The changes to the pension regime here in the UK have been broadly welcomed, but it will be years before we can fairly judge whether they have been a success. The Australian evidence suggests not only that we would be unwise to dismiss annuities altogether – but that without careful management and sound advice, it’s all too easy to run out of money.
1 Interim Report of the Financial Systems Inquiry, ‘Murray Inquiry’, July 2014
² abi.org.uk, July 2015