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Pension freedoms

24 February 2015

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The NHS pension is not straight forward and many community health workers are finding their jobs transferred to private companies. It is therefore, important to understand the liberalising measures being brought in by the government.

It used to be simple. A pension came your way when you retired. If you worked for the NHS, you would almost certainly join the NHS pension scheme, which offered – and still offers – defined benefits upon retirement. Typically a tax free lump sum, plus an inflation-proofed monthly payment for the rest of your days.

An NHS pension meant financial security. Many would cite the pension high on their list of reasons for staying in NHS employment.

Actually it was never quite that simple. For those within the NHS scheme, there have long been incentives to “play the system”- to increase one’s retirement benefits, to find ways of claiming them earlier, or both. And behind the scenes a greater issue was building – affordability. Everyone working in healthcare knows that people are living longer. Increased demand on GP practices and A&E departments is now commonly attributed to the “frail elderly”. Former NHS employees are no exception, typically living years longer – and hence drawing their pension for longer – than a generation ago.

Nor is simple reliance on the NHS pension scheme the norm. Some employees leave the scheme completely, relying instead on private “money purchase” pension arrangements. Some keep a foot in both camps, supplementing their NHS pension with linked additional voluntary contributions (AVCs) or private pensions. And meanwhile access to the NHS pension scheme is becoming more precarious, as increasing numbers of health workers, especially community nurses and therapists, find their jobs transferred to private companies or social enterprises.

So, even for members of the NHS pension scheme, it is important to understand the various liberalisation measures currently being introduced by government. It may be that removing constraints on pensions offer real opportunities. But there is also speculation that 2015 will offer free rein to charlatans offering poor advice, and worse.

Pensions: the basics

The core notion of a pension is disarmingly simple. Cut through the rhetoric and there are essentially two phases: saving for one’s retirement, and then drawing down those savings. Recent liberalisation initiatives address both phases.

“Saving up”

Firstly, there is the “saving up” phase: the amassing of a “pension pot” during one’s working life. For those in public sector superannuation schemes, this process is well defined. The employee pays a percentage of earnings, so does the employer, and the accumulated money is retained in a scheme fund (not a personal “pot”) from which defined benefits will ultimately be paid. At intervals the scheme is reviewed by actuaries – famously, people who decide accountancy offers too much career excitement – and the percentage contributions are recalibrated.

With a personal pension, the process is different. Employees decide how much they wish to contribute, and the accumulated personal “pot” is invested by a fund manager.

Why have personal pensions struggled to attract new business? One obvious reason is the absence of employer contribution. But there is also a lingering perception of poor value for money. Fund managers have failed to dispel the perception of risk arising from stock market volatility, and the reputation of excessive annual management fees. Over a decade ago, so-called “stakeholder pensions” established 1% per annum as a fee ceiling; yet a recent report by the Financial Conduct Authority found that half of all funds are still paying out 1.5% per year or more. Unlike projected future earnings, this represents hard cash lost by investors.`

So the government now appears to be moving towards new fee caps. It presumably hopes these, coupled with investor freedom to move funds from one manager to another, will make personal pensions more attractive.

There is, however, a snag. Interest rates remain very low, historically speaking, and are projected to stay that way for the foreseeable future. Reliance on competition between fund managers to improve investor returns can only go so far – particularly in an industry used to charging embarrassingly high annual fees regardless of performance.

“Drawing down”

It is the “drawing down” phase of a pension that has been attracting most government attention in recent months. Here the conventional model, for those with personal pension “pots”, is the purchase at retirement of an annuity – a monthly income for the remainder of one’s life.

With more and more companies closing their defined benefit pension schemes, annuity purchase has become a route to almost guaranteed disappointment for many more retirees. Alarmed by this reality, in a context of ultra-low interest rates, people with spare cash have been investing in other types of assets, often in property. An entire market – that is buy-to-let housing – has been fuelled by this dissatisfaction over the last decade, with numerous adverse side effects.

So poor is annuity income, and so grasping have firms become – fee levels of 20% are not uncommon – that dismantling restrictions on annuities has become a populist strand of government policy.

Firstly, in last March’s Budget, Chancellor George Osborne put the pensions industry into a panic by announcing that, from April 2015, people who retire will be able to invest their pension pots in any way they wish, rather than being limited to annuities. Behind the initial “pensioners to buy Lamborghinis” headlines lay the prospect of radical change in an industry worth at least £12bn per year. Then, recognising the dissatisfaction of perhaps six million pensioners locked into existing annuity contracts, pensions minister Steve Webb announced in January that this liberty would be extended to existing annuity holders.

As well as people with personal pensions, this is significant for anyone currently “topping up” an NHS pension with AVCs or a private pension. For instance, freedom to defer realising one’s AVC fund, or to re-invest it as a lump sum rather than buying an annuity, may be attractive to people reaching NHS pension age but wishing to continue working part time.

Pensions minister, Steve Webb’s proposals, which envisage pensioners trading projected future incomes for current cash, have been greeted with some scepticism. They may also – Webb being a Liberal Democrat – become mired in pre-election positioning. Chancellor George Osborne’s proposals appear more robust – but, as ever, the devil may prove to be in the detail.

For the pensions industry life has been busy. Commentators highlight the way pensions firms are now promoting annuities as financial safety nets, to cover ordinary month-to-month spending, or even – recognising the prevalence of dementia – our later years when taking ordinary financial decisions can become challenging. They also note an apparent dilution of Osborne’s original promise of “free, impartial advice”, preserving the role of fee-charging financial advisers.


Liberalisation brings risks. Webb’s announcement stresses personal freedom – to crystallise and enjoy one’s savings, to spend one’s wealth as one wishes. But large sums of cash attract chancers, charlatans and worse as surely as the council tip attracts seagulls.

Low interest rates in the conventional market will tempt some into dubious investments. If, for many of us, a house is the biggest purchase we ever make, from April a pension investment will run it a close second. Anticipate rip-offs. There’s nothing to prevent the slick preying on the gullible. The old investment rule still applies. The trade-off between risk, yield and liquidity is absolute. If the promised rate of return looks unlikely, it probably is.

Liberalisation also carries broader risks. Not only are we living longer; we tend to live longer than we ever expect. A state pension no longer covers even the basics of life. Primary care, familiar with the “frail elderly”, may begin to see the return of a group from other times: the destitute elderly.

So – what is a pension?

Pension marketing traditionally emphasises post-retirement lifestyle – the “comfortable retirement” – along with the security of “putting something away” for the unforeseen. But, these worthy aims notwithstanding, a pension fund is no different in nature from any other investment. The normal rules apply. Liberalisation only renders this more important than ever to remember.

Noel Plumridge is a finance columnist.