In a radical change to its 90-year-old retirement system, the United Kingdom plans to decouple annuities from retirement plans. Annuity professionals in the United States can glean some takeaways from the massive disassembling that is about to occur.
Targeted at defined contribution retirement plans, the proposed changes will make it so that people will no longer have to buy an annuity when they retire, according to government officials.
Chancellor of the Exchequer George Osborne broke the news in a speech on the 2014 budget. “Pensioners will have complete freedom to draw down as much or as little of their pension pot [defined contribution plan account], as they want, any time they want,” he announced.
There will be no caps and no drawdown limits, he said. And “No one will have to buy an annuity.”
The changes are slated to take effect in April 2015, following adoption of new legislation which will remove tax restrictions on how pensioners can access their “pension pots” (account values).
Most people “have little option but to take out an annuity,” Osborne said, describing the existing tax rules around defined contribution plans as “a manifestation of a patronising (sic) view that pensioners can’t be trusted with their own pension pots.”
(The existing tax rules allow drawdown of up to 25 percent of account value tax free, but additional drawdowns are subject to a 55 percent tax. This is for people who don’t take an annuity. The proposed new rules would keep the tax-free drawdowns on the first 25 percent but make any additional drawdowns subject to normal marginal tax rates, which are just 20 percent in most cases.)
“People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances,” the chancellor said, adding that the new system will “trust the people.”
Surprise and concern
The U.K. media has responded with a flurry of articles voicing surprise, joy, concern and doubt.
Fraser Nelson, editor of The Spectator, wrote that the proposal “effectively signals the end of the social contract that has underpinned the welfare state since its creation” and rescues pensioners “from the annuities trap.”
But Nelson also asked, “Isn’t there a danger that the oldies will blow it all on Saga cruises and Château Lafite – ending up dependent on government charity in 10 years’ time?”
Some articles report that people are feeling joyous over the new freedom they expect the proposal to bring. Other reports recount how people have started cancelling annuity purchases that they had in the works for 2014, just because of the proposed plans. Still other articles note that people are now uncertain what to do between now and the proposed April 2015 effective date — buy an annuity or not?
Some media quote annuity executives, who are predicting that the U.K. annuity market will shrink anywhere from one-half to three-fourths of its current status as a result of these changes.
Takeaway for Americans
Although the U.K. market is very different from that in the U.S., the proposed no-annuity-required approach provides American annuity experts much to ponder.
For one thing, it appears that the U.K. is positioning annuities closer to the position they hold in the U.S. — that is, they are a product that is chosen, not something forced upon a person by a government system. (Even the in-plan annuity proposals in the U.S. say the plan sponsors will elect to offer an annuity to defined contribution plan participants as an option.)
Another thing to note is that, in the U.K. proposal, the government is not spurning annuities. In fact, the proposal allows pensioners to buy an annuity if they want.
As the chancellor put it, “Those who still want the certainty of an annuity, as many will, will be able to shop around for the best deal.” In addition, the chancellor said the plan calls for a “right to advice” that guarantees affected retirees will be offered “free, impartial, face-to-face advice” on available choices.
Portrayed this way, annuities will take their place among other options and be subject to buyer choice as are other options. That is the way it is in the U.S. — a point that annuity specialists may wish to underscore with annuity-bashers who come their way.
However, if the early reports are accurate — that the proposal is prompting thousands to already cancel their plans to purchase an annuity this year— it would seem that some people are spurning annuities, even if the U.K. government isn’t.
It is likely that U.S. annuity specialists will view the rush of cancellations as within the realm of the expected. After all, U.S. advisors already know that annuities are not the solution for “all.” They already know that consumers hold back on deals during times of legislative and regulatory change. And they are already accustomed to selling annuities in a choice-based environment where some people buy the products while others do not.
But U.S. advisors will keep an eye out for indications about whether the image of annuities gets tarnished as the U.K. changeover unfolds — for example, if people interpret the government’s action as an indication that there is something “wrong” with annuities. Although such interpretations would be localized to the U.K., the concern is that feelings do travel across borders (and ponds).
Another issue to watch has to do with the nagging question posed by The Spectator’s Nelson. Will the “oldies” just cash out their defined contribution accounts and blow it all?
Agents and advisors in the U.S. grapple with that same question week in and week out, as have U.S. retirement experts and policymakers. Like it or not, raiding the 401(k) account is a huge temptation for individuals. The raids are made possible by a choice-based system where retirement decumulation options are offered but not mandated.
For the U.S. and now also in the U.K., people will not only need multiple options but also plenty of education around the impact of the options on retirement security. Ideally, this education will include assessment of retirement needs, risks, goals, circumstances and yes, whether the person needs the guaranteed income that only an annuity can provide.
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