For anyone interested in UK policymaking, the Budget 2014 policy document Freedom and Choice in Pensions is an exhibition piece: a huge, historic change to rules on defined contribution (DC) pension saving removing any obligation to obtain a secure pension income, backed up with a social science ‘evidence base’ on people’s financial behaviour comprising a single chart (proportion of individuals with a ‘savings orientation’, if you’re interested).
For those that suspect the whole ‘pensions revolution’ announced at Budget 2014 was not a normal piece of policymaking, this is a key clue. It is unthinkable that the changes could have got through the normal policymaking process of other Whitehall departments, not least Department for Work and Pensions.
Since Budget 2014, the pensions policy community has been busy building up some sort of evidence base to make sense of the reforms. For this reason, the Strategic Society Centre recently published Defined Capability, which used the Wealth and Assets Survey to examine the financial capability and behaviour of DC savers before and after retirement.
Perhaps unsurprisingly, the findings suggest average financial capability among DC retirees that is well below the levels implied by the ‘trust individuals’ line the Treasury has stuck to since last year. Just take the fact that one quarter of DC workers approaching retirement don’t have a savings account or an ISA. Or the fact that across multiple measures of financial engagement and use of information, financial capability declines with age. And rather than blow their savings on a Lamborghini, the research highlights the opposite risk from the April changes, if individuals engage in the kind of ‘over-saving’ observable from the findings, and simply put their DC pension pots in their current account and leave them there as ‘buffer savings’.
The last year has also seen growing interest in the experience of other countries with freedom and choice for DC pension savers; in particular, Australia, where most DC pension pots are spent on property and vehicles, and the recent Murray Inquiry concluded the freedom and choice regime directly results in lower incomes among both retirees and workers.
Debate on how to minimise the problems flowing from the April 2015 changes has also advanced quickly and a new consensus is emerging in the pension policy community for the application of a new, regulated default option for DC retirees. Indeed, to accompany our recent research, the Strategic Society Centre has proposed the government should:
- Define, implement in regulation and promote a default ‘automatic income plan’ for DC retirees in the UK, while retaining the right for individuals to withdraw their savings from the age of 55 subject to their marginal income tax rate;
- The default automatic income plan should provide a predictable, secure (guaranteed) and good-value income for DC retirees.
The eagle-eyed reader will notice a precedent for the application of such liberal paternalism in the form of a ‘default’ option – the government’s own ‘auto-enrolment’ reforms to workplace pension saving. Indeed, there is a lot to be said for aligning the choice framework for people in both the pension accumulation and decumulation phases.
Having invested so much in the ‘we trust individuals’ line, it is unlikely current ministers will reach for the ‘default button’ any time soon. However, for future ministers, the application of a default policy approach at retirement for DC savers looks not just likely, but inevitable, given there aren’t really any downsides. While some will whinge about default options being sub-optimal for some people, the relevant counterfactual is not everyone making optimal decisions about their DC savings, but lots of people with unnecessarily low incomes and impoverished retirements (i.e. Australia).
It is only a matter of time until the next ‘pensions default’ for UK pensions policy.
