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Auto-protection at 55

The Centre for Policy Studies welcomes the liberalisation of annuities, first proposed by the CPS in a 2010 report Simplification is the Key. However auto-enrolment is only one side of the coin – the other side is auto-protection to ensure that savers are able to retire with a sufficient pension.

In a new report Auto-protection at 55, published by the Centre for Policy Studies on Friday 20 February, leading pensions expert Michael Johnson urges the Government to introduce auto-protection – that is, a default option for people approaching private retirement age whereby their pension pot would be automatically enrolled in a not-for-profit national auction house for annuities.

The report includes forewords from both the Conservative Peer Lord Holmes of Richmond and Nigel Stanley, Head of Campaigns and Communications at the TUC.

Michael Johnson explains:

The 2014 Budget abolished the obligation to annuitise pension pots. While this liberalisation is welcome, there are legitimate concerns that some people may fail to purchase suitable retirement income products.

People approaching retirement need to be encouraged to purchase retirement income products that limit downside risks, notably longevity, investment and inflation risks that almost all of us are incapable of managing by ourselves.

However, there is a risk that the current Pension Wise guidance service will disappoint. It is not intended to deliver what people want, which is advice, i.e. which specific transactions to execute, and with whom.

Meanwhile, we are tip-toeing around a major issue, rarely discussed. Today’s private pension age (currently 55, rising to 57 in 2028), is an anachronism that is out of step with post-war improvements in life expectancy. It should be rapidly raised to 60 in 2024, i.e. by a year every two years, commencing in 2016. In addition, politicians should be preparing people for 65 by 2030-35.

Furthermore, it is time that we confronted another inconvenient truth: by offering tax-free status on the first 25% of a pension pot, we actively discourage people securing a pension at the age of 55. This is daft, when the alternative is a pension 33% larger than otherwise, which would help mitigate the risk of running out of money in retirement. In addition, as an incentive for long-term saving, it is wholly ineffective.

Ideally, the 25% tax-free lump sum should be scrapped (with accrued rights protected), perfectly justifiable given that recipients would have already received up-front tax relief on their contributions. Given political sensitivities, access should first be pushed back until the age of 60 or 65.

The report proposes seven policy reforms:

Proposal 1: The Government should establish a not-for-profit national annuities auction house to automate the process of shopping around, adding to pricing tension and transparency. This would be akin to making the exercise of the Open Market Option mandatory. All aspiring annuity providers (which could include the state) would be required to participate. Initially, only a limited number of standardised single- and joint-life, inflation-protected lifetime and deferred annuity contracts would be listed. Pre-auction aggregation of small pots by the house would encourage stronger bids.

Proposal 2: The Government should introduce a pension pot decumulation default when savers reach the private pension age: “auto-protection”. Ideally, it would take the form of an inflation-linked pension, joint-life for married savers. Savers would be free to opt out to pursue alternatives, consistent with the liberalisations announced in the 2014 Budget.

Proposal 3: Today’s private pension age of 55 (rising to 57 in 2028) should be rapidly raised to 60 in 2024, i.e. by a year every two years, commencing in 2016. In addition, politicians should be preparing people for 65 by 2030-35.

Proposal 4: Those who defer taking a default pension until at least five years after the private pension age could be rewarded with a pension exempt from Income Tax, paid for by a reduction in upfront tax relief.

Proposal 5: The guidance guarantee should form an integral part of the auto-protection process, to help savers select the most appropriate form of pension (including whether to defer for a tax-free pension, and determining eligibility for health-related enhancement) or, indeed, whether to opt out altogether.

Proposal 6: The state should be free to offer default private pensions, perhaps via the Post Office and National Savings (acting as agents for the Treasury).

Proposal 7: Access to the 25% tax-free lump sum should be delayed until the age of 60 or 65. Alternatively, it should be scrapped, with accrued rights to it protected.

Click here to read the full report.

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