Six months ago, George Osborne kicked off what looked like an enormous shake up of the pensions industry – new freedoms that would give those with defined contribution pensions the ability to take their entire pension as a lump sum, with the first 25 per cent free of tax and the usual rate of income tax on the remaining 75 per cent.
The initial fear was that the government had given pensioners too much freedom: critics worried about retirees cashing in their pensions and spending rashly, racing away in brand new Lamborghinis. Six months on, although I’ve yet to see any Lambos on the school run, hundreds of thousands of people have taken advantage of the option to draw down a lump sum.
However, with the benefit of hindsight, I don’t believe the pension freedoms went far enough to shake the industry up in the way that Osborne perhaps would have hoped.
Freedom means something very specific to me, which is that you have the opportunity to do what you want, without barriers. In the case of pensions, this should mean that you are able to invest in any asset class or product you wish without penalty.
In practice, however, this isn’t the case. And if you look beyond the headlines, there are lots of obstacles which stop people taking full advantage of pension freedoms.
For example, many Sipp trustees require their customers to come via advisers. Consequently, these customers will end up paying more than simply the cost of their Sipp. Obviously, financial advice is appropriate for many people, but it isn’t for everyone. Advice is helpful when it’s required, but when it isn’t needed, it can act as a barrier to entry. Why should a sophisticated private investor be forced to pay to take financial advice in order to move his or her investments?
Second, investors in Sipps are restricted by a list of standard and non-standard assets, in which investments are categorised based on the judgement of risk by a third party. This is a capital adequacy requirement, and investments which are not on the standard asset list cost providers more money to hold.
This is an important point for the alternative finance industry: RateSetter is leading calls for peer-to-peer lending to be included as a standard asset, because the assessment of risk is obviously out of date in this case. Single stocks and equity funds are commonplace on the standard list, and the volatility (a key measurement of risk) in equities at the moment is pretty erratic.
Peer-to-peer lending is definitely a passive investment, and although capital is at risk, we believe that the consistency of returns and lack of volatility surely make it a candidate for the standard list. These rules restrict investor choice: at the moment, we’re the only major platform that people can invest in through a Sipp, but updating the list could lead providers to offer more peer-to-peer investments to their investors.
The potential problem here is that investors may appear free – the rules have been relaxed – but in practice there are very significant obstacles which could cause many to stick with the status quo and fail to exercise their new-found freedoms. These investors risk missing out on what these changes set out to deliver: freedom and choice in pensions.
The government’s work to date has been significant, but if pension freedoms are to be meaningful, it should be considered a first step. There’s lots more to be done.