Posted by James McNeile, Partner
On 1 September 2016 Withy King LLP merged with Royds LLP. The trading name for the merged firm is Royds Withy King. All content produced prior to this date will remain in the name of the firms pre-merger.
Dirty (pensions) tricks! – Insurers mount an increasingly desperate rearguard action
In the last few weeks we have been bombarded by press stories warning of “the most horrendous retirement income car crash” next year, that 200,000 pensioners will “blow their pensions” next year, and that HM Revenue and Customs will be overwhelmed next year and will apply emergency tax codes to any payments from pension schemes, so that 40% (or even 45%) tax will be applied to payments as low as £17,000.
You will recall that one of the surprises – perhaps the biggest surprise – of George Osborne’s Budget this year was the announcement that members of defined-contribution schemes over the age of 55 could take all their pension fund out whenever they wanted. The drawback was that only 25% would be tax-free. The rest would be treated as income of the tax year in which it was received.
Now, with respect, that is not a difficult concept to understand.
The only problem was that the insurance companies, who had been making vast profits (estimated at between 15% and 25%) out of selling annuities to pensioners, suddenly saw those profits about to disappear. An annuity is another simple concept – you give an enormous amount of pension money to an insurer, and the insurer pays you a guaranteed income for life. Quite how the insurers manage to guarantee the payments is something of a black art. Annuities are generally understood to be linked to UK Government gilts, that is, a secure but low-yielding investment, but that does not altogether explain the level of the insurers’ profits. It stands to reason that if yields on investments are low, you need more investments to meet the guarantee – therefore annuities are very expensive at present – but low yields ought also to mean low profits, which is clearly not the case. There appears to be more going on here than meets the eye. Is the high price of annuities simply a device to protect the insurance companies’ high profits?
It appears the Government thought so. Before 2006, it was compulsory for a member of a defined-contribution pension scheme to buy an annuity by the time he or she reached the age of 75. But in a little-publicised piece of legislation, hidden away in the small print, that requirement was removed. The justification was that the Plymouth Brethren (yes, really!) had a deep religious objection to sharing mortality risk with people who were not members of that sect, so there had to be some accommodation for them. However, when the wording of the draft law appeared in 2004, the removal of the requirement to purchase an annuity applied to all. The Government called it “alternatively secured pension” – a term worthy of Sir Humphrey in Yes Prime Minister, as it actually meant totally unsecured pension.
Pensioners retiring after 2006 were still able to buy an annuity – of course, as pension providers and independent financial advisers gained a great deal of money from selling them. But gradually over the years pensioners have become more and more upset over what they now see as very bad value for money. Back in 1990, a pension fund of £100,000 would have bought you an annuity income of £16,500 a year. In 2014 the same £100,000 would buy you about £5,800 a year. Depressingly, for smaller pension pots (and the national average is around £65,000), insurers offer even lower rates.
It seems likely that the Government put pressure on the insurers to improve the deal they were offering to pensioners. But the insurers did very little. So in his March Budget speech, Chancellor George Osborne said,”The annuities market is currently not working in the best interests of all consumers. It is neither competitive nor innovative and some consumers are getting a poor deal. . . . The Government backs savers and wants to give them the freedom and choice to get the best deal possible.”
So if you are an insurance company about to lose most of your annual profits, what do you do? You point out to unsuspecting pensioners how dire the consequences will be of taking all your pension cash in one lump. The insurance companies hope that if they make enough fuss, the Government will see sense and repeal the ill-thought-out legislation. But you will note that even the Labour Party had to admit (through clenched teeth) that they supported the Government on this point.
What the new pension freedom actually means is that a pensioner will be able to leave his pension “pot” in his pension fund, where income and capital gains are tax-free, and draw down from it when he needs the money. He is a taxpayer like everyone else, and he understands income tax. He is not too stupid to realise that if he takes a large lump sum, say for a buy-to-let property, 75% of the sum will be taxed as income for that tax year. So given an income of 5% a year from the property, and static or falling property prices, and possible hassle from the tenants, is it worth doing? That decision is entirely up to the pensioner, as it should be. What the pensioner could do with the money instead is to instruct his pension provider to invest his pension “pot” in a basket of UK real-estate investment trusts, which have risen in value by a tax-free 21% (plus a 4% dividend) in a year when the FTSE 100 has been completely flat. It’s just a question of changing your perceptions.
So to suggest that pensioners will blow all their money is insulting and simplistic. Or as one blogger put it: “You save all your life and then like a fool you’re going to blow it all and live in poverty. How patronising!”
Who will regulate the regulators?
Take this situation – a small family trading company suffers in the 2008 recession and struggles on until February of this year, when it goes into liquidation. The company had set up a small self-administered pension scheme for its directors, and, like many such schemes, had bought the freehold of the commercial property from which it operated. The scheme had also bought, using a mortgage, another commercial property in Central London, which was, and remains, leased out to good tenants. Those properties are the scheme’s sole assets.
The founder director and his wife, now in their seventies, had been receiving a pension from the scheme. When the struggling company could no longer afford to pay rent to the scheme, the pensioners realised they could not insist on their pensions being paid, as this would cripple the company they had spent their lives building up. So from 2010 the pensioners lived on the state pension and their savings. By the time the company went into liquidation, they were owed a total of £90,000 in pension from the scheme.
But, you say, there is now an empty property owned by the scheme. Can that not be sold, and the proceeds of sale used to pay the pensioners their pensions?
No, says one of the director trustees. He has managed to fall out with the other members of his family, and the law requires all the scheme’s trustees to consent to the sale.
Until April 2005, if a company with a pension scheme went into liquidation, the liquidator was obliged by the Pensions Act 1995 to appoint an independent trustee to the scheme. That independent trustee took over all the powers of both the company and the scheme trustees. If the liquidator did not appoint a new trustee, any of the members of the scheme had the power under the Act to apply to Court for an order requiring the liquidator to fulfil his obligation.
After April 2005, this power was taken from the liquidator and given to the new Pensions Regulator. However, the Regulator was not required to appoint a new trustee, and the members’ power to enforce such an appointment was taken away. The Regulator was instead given the discretion to appoint a new trustee “to secure the proper use or application of the assets of the scheme, or otherwise to protect the interests of the generality of the members of the scheme.”
So, given those provisions in the legislation, what would one expect in this situation? One would expect the Pensions Regulator to appoint an independent trustee immediately. Bear in mind that the new trustee is truly independent, and will not necessarily decide to sell the vacant property. But, after due consideration, he may. The members of the scheme deserve to have that chance.
In this case the Pensions Regulator refuses to exercise his discretion to appoint a new trustee. In order to avoid a complete impasse, the members of the scheme have no option but to apply to the High Court for an order that the property be sold. That will cost in the region of £15,000, and will take at least a further six months.
It is difficult to see how forcing the scheme members to take the matter to the High Court can possibly be “protecting the interests of the generality of the members of the scheme”. However, the Pensions Regulator is a creature of statute, and nothing in the statutes allows scheme members to appeal his decisions. As the Roman poet Juvenal would have remarked in this situation: Sed quis reguliet ipsos regulatores – “But who will regulate the regulators?”