“We want freedom and choice and we want simplification too”.

Pensions. Tax. Benefits. Each over-complex. When combined: lethal. We shouldn’t blame pension freedoms for the mistakes caused by governments’ habit of making everything too complicated. We want freedom and choice and we want simplification too.

— Stuart Fowler (@fowlerdrew) February 22, 2019

Stuart’s right. I read this after reading the “factsheet” shared in Jo’s earlier post.

Here is a 20 page factsheet on how dipping into your pension pot from age 55 can affect benefits, such as housing benefit and pension credit. It’s a very complex area and very easy for the unwary to slip up. https://t.co/VVWL6N0s3y

— Josephine Cumbo (@JosephineCumbo) February 22, 2019

I suspect that the factsheet reference is ironic. I doubt that you could get all the information in the Age UK report onto a king-size double bedsheet.

I speculate – but it may have been the experience of reading AgeUk’s instruction manual that prompted Jo’s outburst in the FT.

What price pension freedoms? https://t.co/McJqAbebw4 via @financialtimes

— Josephine Cumbo (@JosephineCumbo) February 22, 2019

Stuart is right, we can’t have our freedoms without complexity and “to live outside the law we must be honest”.

The five unseen consequences of pension freedoms.

Jo Cumbo’s article, which is behind a paywall ends like a Mahler symphony with wave after wave of crashing intensity. I hope that the FT will not be too angry if I quote the mighty crescendo on this blog.

Five traps of pension freedoms

From tax traps to scammers, pension freedoms have exposed investors to a range of new risks.

1. PAYING TOO MUCH TAX

Since freedoms were introduced in 2015, more than 170,000 savers have been overtaxed to the tune of £400m due to the inflexibility of the tax system. Under current rules, beyond the typical tax-free lump sum, pension withdrawals are taxed at an individual’s marginal rate.

However, when a lump sum is first taken from a defined contribution pot, HM Revenue & Customs requires pension providers to apply a temporary tax rate — which can often put savers into a higher tax bracket. This could result in individuals paying thousands of pounds more in tax than they should. The saver will then need to reclaim the overpaid tax from HMRC.

In a separate tax trap, almost 1m over-55s risk receiving unexpected tax bills after dipping too deeply into their retirement funds; the most common way of triggering the Money Purchase Annual Allowance (MPAA) which slashes the annual allowance from £40,000 to just £4,000.

2. BONANZA FOR SCAMMERS

Easier access to pensions cash has proved a bonanza for fraudsters. Last year, the over-55s were hoodwinked out of an estimated £200m by pension scammers. However, industry experts believe up to £1bn of pensions fraud has been committed in the past decade, as not all of it is reported.

Scammers typically use tactics such as cold calling individuals and offering them a free pension review. Savers are enticed to invest their life savings in high-risk or unsuitable assets offering returns that are too good to be true. A ban on pensions cold calling came into force in January, but this was too late to help many victims.

3. PENSION TRANSFER MIS-SELLING

Pension freedoms have opened up new opportunities for savers to give up their generous final salary-style pensions for eye-watering lump sums. The regulator believes giving up a defined benefit pension, which pays a secure income for life based on salary and length of service, is not the best route for most people.

But thousands of savers may have been badly advised to trade their valuable benefits for a cash lump sum today, and transfer it to a riskier DC pension where the funds can often be invested in high-charging and unsuitable assets. In a recent review by the regulator, fewer than half of transfers were deemed sound enough to have proceeded. Experts now believe a new pension transfer mis-selling crisis is unfolding.

4. POOR DEALS FOR DRAWDOWN INVESTORS

The Financial Conduct Authority has found that consumers acting without the help of an adviser are at greater risk of poor deals. According to the FCA’s analysis, nine in 10 investors who went into drawdown without the help of an adviser chose the path of least resistance and took the deal offered by their existing savings provider, compared with 35 per cent of advised customers.

Given this lack of competitive pressure, the FCA said it was concerned that consumers might pay too much in charges. Its analysis found that charges for non-advised drawdown consumers varied from 0.4 per cent to 1.6 per cent between providers. By switching from a higher cost provider to a lower cost provider, consumers could increase their annual income by 13 per cent, the FCA found.

5. CASH TRAP

The FCA found some drawdown providers were “defaulting” consumers into cash or cash-like assets.

Overall, a third of non-advised drawdown consumers were wholly holding cash.

Holding funds in cash may be suited to consumers planning to draw down their entire pot over a short period. But it is highly unlikely to be suited for someone planning to be invested over a longer period, who will be losing out on valuable retirement income. FCA analysis found that 33 per cent of consumers who do not take advice held their whole drawdown pot in cash accounts or exclusively in “cash-like” funds.

What will it take to assist, guide and equip the nation?

The pension freedoms were born into our world without incubation, without mass market pension awareness and with advice as accessible to most people as private education.

By incubation, I mean the means of inducing a new pension paradigm. There was no consultation, Pension Wise was introduced as an advisory service but turned out as little more than you could get from a 30 minute Youtube video.

By pensions awareness, I mean the capacity to find and take in the 20 pages of the Age UK factsheet.

By likening advice to private education, I draw parallels with the two-track systems where the majority of us (94% according to the FCA), muddle through on what we can do for ourselves, while a privileged few reap the benefits of the new pension paradigm.

The only way we can simplify these 20 pages of decisions is to create default pathways that ordinary people can follow without fear of falling foul of complexity.

CDC is one such pathway and I hope that it will be encouraged as a scheme pension alternative to an annuity.

The guided outcomes being investigated by the FCA, may simplify the decision making for those who don’t take advice, reducing the risk of falling into the “five traps”.

But there must be a fundamental shift in people’s awareness of what is going on with their money and the choices they have in retirement. I do not think it is impossible to get people to engage with the pension system and make sense of it. Millions have done that with equally complex financial decisions – house purchase for instance – understanding universal credit as another.

But to assume that the status quo is satisfactory is to ignore the magnitude of Jo’s five traps. The Age UK factsheet reminds us what it takes to be a pensions expert these days. We need to have a support network of pension experts capable of helping people to understand the implications of the decisions they are taking in retirement and that is the challenge facing the Single Financial Guidance Body.

I think it totally unfeasible for the public sector to accomplish the task of equipping up to a million people who reach retirement each year. The private sector must be involved and must be commercially rewarded. This means looking again, not just at product, but at the rules governing advice and guidance and the incentives to provide people with the help they desperately need.