New SMF report calls for Early Warning System to protect retirees and taxpayers
April’s “pension freedom” reforms pose serious long-term financial risks to retirees and taxpayers, concludes a new report that highlights the experience of pensioners in countries which already allow similar access to pension cash.
New research published today by the Social Market Foundation (SMF) says countries such as Australia and the USA provide real-life examples of the potential downsides of pension freedom and calls on the Government to develop an ‘Early Warning System’ to identify emerging risks both to consumers and taxpayers.
The report, Golden Years? What freedom and choice will mean for UK pensioners, says few Australians or Americans choose to secure a guaranteed income for life. Instead it found three types of behaviour which were common among retirees:
- ‘Cautious Australians’ who preserve their capital by reducing it by less than 1 per cent a year.
- ‘Quick-spending Australians’ who consume pension funds quickly with four-in-10 running out by age 75.
- ‘Typical Americans’ who on average consume pension savings quite quickly with an average withdrawal rate of 8% per year.
Using new modelling from the Pensions Policy Institute Golden Years? reveals the implications for UK retirees with Defined Contribution pension savings were they to copy these behaviours. Headline findings from the modelling include:
- Retirees emulating the ‘Typical American’ or ‘Quick-spending Australian’ would exhaust their pensions by year 17 and year 10 respectively – long before they reached average life expectancy.
- Those who use the new rules to access pension cash early in retirement may maintain their working-life standard of living for a while, but risk it falling sharply in later life compared to those who choose sustainable income and more even consumption.
- State Pension and Benefits may keep retirees above the definition of poverty, but their incomes risk sinking towards poverty levels if too much pension is taken too early.
- Retirees following the ‘Cautious Australian’ path of under-consumption face a very low risk of running out of savings, even if they live longer than average. But this comes at the cost of reduced incomes and lower living standards throughout retirement.
- For UK retirees choosing income drawdown, variable investment returns can result in uncertainty of income in retirement and of the age at which pension savings run out.
- Decumulation choices also affect fiscal risks to the state associated with the costs of claims of means-tested benefits. For instance, if a man with a pension pot of £184,000 takes the ‘Quick-spending Australian’ decumulation path, this would cost the state over £10,000 more by the point of average life expectancy (age 87) than had they bought an annuity.
The research also suggests that particular groups may be more vulnerable to poor outcomes following the reforms, including women, early retirees, those who access their pension savings before retirement and those without any other assets.
The report argues that the Government should create a two-tier ‘Early Warning System’ to understand what retirees are doing with their pension savings and to identify emerging long-term risks both to consumers and the taxpayer. It recommends:
- A ‘Retirement Risk Dashboard’ – to help the Government monitor retirement decisions and provide a view on long-term outcomes for consumers and the State. This would be based on a range of statistics such as pension balances, pension cash withdrawal, insurance take-up, levels of investment risks and take-up of guidance and advice.
- ‘Personal Pension Alerts’ – to help policymakers intervene where appropriate with the sub-groups it has identified as at particularly high risk. Potential interventions could include: targeted support and advice; initiatives to make retirees think twice before taking one-off decisions such as withdrawing all their pension savings; and, a ‘Mid-Retirement Financial Health Check’ to encourage older people to reconsider their financial position for their later years.
Nigel Keohane, one of the report’s authors and Social Market Foundation Director of Research said:
“Pension freedom may be new to the UK but such approaches have been well tried and tested elsewhere. Our research into the real-life experiences in Australia and the USA provides evidence on the range of long-term risks facing retirees and the State, whether that is exhausting a pension pot early, a low standard of living in later life or taxpayers picking up the bill for more means-tested benefits.”
“If we really want to know how pension freedom is progressing and avoid such detrimental consequences, we need to introduce an early warning system to monitor retirement decisions, understand the long-term implications and ensure consumers receive the right support.”
Notes to Editors:
- A copy of the report is available at the following link: Golden Years? What freedom and choice will mean for UK pensioners.
- The report is supported by Just Retirement. The modelling for UK retirees based on international experiences was carried out by the Pensions Policy Institute (PPI). The SMF retains absolute editorial control over its outputs.
- The Social Market Foundation (SMF) is a leading independent UK think tank which develops innovative ideas across a broad range of economic and social policy, champions policy ideas which marry markets with social justice and takes a pro-market rather than free-market approach smf.jynk.net.