Budget 2014 pension reforms: increased flexibility, but for whom?

In Budget 2014, George Osborne announced significant changes to the way many will be able to access funds in defined contribution (DC) pensions. These changes will extend to a wider group the flexibilities already available to some. The reforms could have wide-ranging implications for the level and profile of individuals’ retirement incomes, their welfare, demand for different financial products, and demands on publicly funded means-tested support for pensioners.

This observation aims to shed light on how many people might be affected in the next few years and how these people might respond by describing the proportion and characteristics of people currently aged 55 to 74 who are likely to have been affected by the Budget announcements. We draw on data from the English Longitudinal Study of Ageing (ELSA) collected in 2010–11. This observation summarises some of the key messages that are described in more detail in tables and figures published today, which will form part of a presentation by Carl Emmerson at an event hosted by the Strategic Society Centre.

Prior to April 2014, most people with a DC pension faced a strong incentive to buy an annuity with their pension fund by the age of 75 because otherwise they faced a tax charge of 55% on assets withdrawn from the fund. They could alternatively take up to one-quarter of their fund tax-free and purchase an annuity with the remainder of their pot, with the annuity income then being taxed at their marginal income tax rate. Two groups of people had more flexibility than this, however. First, those with only small amounts of money in DC pensions were able to withdraw the whole amount, receiving one-quarter tax-free and facing tax at their marginal rate on the other three-quarters. This applied to up to three pension pots worth no more than £2,000 or to all pension funds if an individual’s total private pension wealth was below £18,000 (provided the pension provider(s) concerned allowed such ‘trivial commutation’). Second, those relatively well-off individuals who could demonstrate that they had at least £20,000 a year of other secure annuitised income could withdraw as much as they wanted from their remaining pension funds and face tax at only their marginal rate (known as flexible drawdown).

What the Budget announced was essentially that the flexibilities available to those with small pots or a high level of annuitised income would be extended to all. From April 2015 onwards, all individuals aged 55 and over will be able to withdraw as much as they want from their DC pension funds and face income tax at their marginal rate, rather than 55%.

How people, and markets, will respond to the changes announced in the Budget will depend, at least in part, on who it is that has been affected: How much DC pension wealth do they have? What other forms of retirement resources do they hold? What are their other characteristics?

A significant fraction of individuals will be entirely unaffected by George Osborne’s announcements – either because they have no money in DC pensions or because they were already eligible for trivial commutation or flexible drawdown. The tables and figures published in our briefing note today describe the number and characteristics of those aged 55 to 74 who are likely to be affected. By focussing on those already aged 55 to 74, our figures give a picture of the potential near-term impact of the reforms. (The number and characteristics of people affected in later cohorts – among whom DC pension membership will be much more widespread – are likely to be different. We do not attempt to characterise them here.) For much of the analysis we focus on those aged 55 to 59 since these individuals are more likely not to have already purchased an annuity.

We estimate that about half of men and two-thirds of women (or six-in-ten of all) aged between 55 and 59 have no money currently held in DC pensions. There are two other smaller groups of individuals who are also likely to be unaffected by the Budget announcements – those whose DC pots are below the trivial commutation thresholds (8%) and those who we estimate will have at least £20,000 of secure income from state pensions, defined benefit (DB) pensions and already annuitised DC pensions (2%). This leaves just under four-in-ten men and just over two-in-ten women (or three-in-ten of all those) aged between 55 and 59 who will experience greater flexibility as a result of the Budget changes.

As the table shows, nearly 60% of those likely to get additional flexibility are men. Those affected are generally in better health, better educated and more likely to own their own house than the average. They also expect to live longer.

The amount of money held in DC pension funds by this group of people varies widely. Half of them have less than £53,000, but one-in-four of them hold more than £116,000 in DC pension funds. However, DC pension wealth is only one component of the household wealth portfolio for this group. There is considerable variation in the importance of DC wealth within the portfolios of those likely to get greater flexibility: for around half of them DC wealth accounts for less than 10% of their total household wealth. For just over half of those likely to be affected, DC wealth is their only form of private pension wealth, but just over a quarter actually hold more wealth in DB pensions than in DC funds. The figure below shows that private pension wealth as a whole makes up on average a third of total household wealth for those who might get greater flexibility.

Overall the group who might get more flexibility has higher average wealth than those unlikely to be affected by the reforms: we estimate that those getting more flexibility have median wealth of £680,000, compared to £550,000 among those unaffected.

These characteristics suggest that those who will get greater flexibility might be relatively well-placed to receive, and to act appropriately upon, information, guidance and advice that they are given over how to manage their own finances. However, the fact that they are in relatively good health and expect to have a greater than average chance of living to older ages may complicate their retirement planning and potentially increase the costs of making an inappropriate decision. One concern that has been raised about this policy is that the greater flexibility will allow people to spend all their funds quickly and then fall back onto taxpayer-funded means-tested benefits. However, the figures presented here suggest that – in the near-term at least – this may not be a significant concern, as the vast majority of those most likely to get the greater flexibility are home owners (and thus unlikely to qualify for housing benefit) and on average have significant other assets in addition to their DC funds. The picture is likely to look different in the longer-term, however, as DC pension coverage becomes much more widespread.

Notes: Sample size = 2,015.
Source: Authors’ calculations using English Longitudinal Study of Ageing, wave 5 (2010–11).

Notes: Sample size = 2,015.
Source: Authors’ calculations using English Longitudinal Study of Ageing, wave 5 (2010–11).