The Blog

Is It Wise That the UK Has Dropped the Need to Buy an Annuity?

Now that the dust has settled on the UK general election and the new Pensions Minister Ros Altmann has been appointed, it is timely to look at the major pension reforms that have happened in the UK - many of which have gone relatively unnoticed but which will have significant and long lasting impacts on people once they reach retirement.

April 6 was a landmark day for everyone in the UK. Why? Not because it was Easter Monday, but because it was the day that UK workers were no longer required to purchase an annuity at retirement. People aged over 55 now have the choice to cash in all or part of the savings nest egg that they have built over a lifetime at work.

This concept of being able to access a lump sum on retirement has been the cornerstone of the Australian superannuation system for many years.

Yet, with people living longer and concerns about retirees having enough to live on throughout their retirement years, Australia is now questioning the wisdom of this approach.

We have a situation where the UK is adopting some of the key lump sum elements of Australia's system, at the same time Australia is looking to annuities which have been such a dominant feature of the UK system.

The UK is now facing many of the same issues and questions - both real and perceived - that we have faced in Australia.

When you retire, will you blow all of your retirement savings in one go? Will you live it up, pay off existing debt, or buy a fancy car, as suggested by the previous pensions minister? And will there be armies of unscrupulous scammers looking to entice people into bad investments that are too good to be true and prey on those who are cashed up and looking for answers?

Despite free guidance being provided to over 55s through the Pension Wise service people will still be left to their own devices to decide what to do with their life savings. This can be good for some but also disastrous for others. The Financial Conduct Authority has warned that people who cash in could be left destitute in retirement.

What we have found in Australia is that most people tend to gravitate towards default savings offerings where someone else makes the investment decisions about their lump sum for them. In fact a recent development is that retirement fund providers are required to provide a simple, low-cost default scheme for those who don't want to make the decisions themselves.

This is a useful safety net but it doesn't cover everyone.

While there is something to be said for the human survival instinct, that desire that many people have to make their money last through their retirement so they can maintain their standard of living and not be forced to rely on the government in old age, it must also be remembered that levels of financial literacy in the community are low.

A recent study by the University of Sydney Business School found that fewer than half of those involved in the study can answer basic questions on interest rates, inflation and the diversification of risky assets. It concluded that this large cohort is much less likely to be prepared for retirement and is therefore highly vulnerable.

It is a conclusion reinforced by an ANZ Bank investor survey this month which found the number who could recognise an investment as "too good to be true" fell from 53 per cent in 2011 down to 50 per cent.

Common sense, rational thinking about making your money last and even the work of the Pension Wise service will only go so far in helping retirees to not blow their pension pots. The Australian experience with lump sum payouts is that much needs to be done to boost financial literacy, and these are learnings that UK policy makers - and retirees -- would do well to heed.

Alex Malley is chief executive of CPA Australia