Bob Champion: Why later life lending is set to grow

The latest data bulletin from the FCA suggests that later life lending is set to grow, writes Bob Champion, as savers with small to medium sized pots struggle to avoid the poverty line

The Financial Conduct Authority’s (FCA) latest data bulletin looks at analysis on how people are using their pension pots following the pension freedom reforms. There are four things that are attracting the attention of commentators:

  • The numbers going into income drawdown without seeking advice
  • The numbers that are withdrawing more than 8% of their drawdown fund
  • The numbers that are cashing in their pensions
  • The numbers that are not taking advantage of annuity guarantees within their pensions

Firstly, we must raise an issue with the numbers because it’s important to point out that the data set here is incomplete. The FCA numbers come from the providers they regulate; Occupational Pension Schemes that are regulated by the Pensions Regulator do not give returns to the FCA. If a member of one of those schemes cashes in their pension or takes a partial lump sum those numbers would not be included in the FCA data. However, if funds were transferred to a FCA-regulated firm to access drawdown or buy an annuity then those numbers would be included.

Another problem is that we do not know the impact of other pension savings on the behaviours being exhibited. Many people have more than one pension; they may also have a defined benefit pension.

However, subject to the above caveats, the data shows 12% of people used their defined contributed (DC) pension pot to buy an annuity. This is consistent with previous FCA data releases. The percentage is almost 20% for those between £30,000 and £100,000; only 6% of those pots below £10,000, and 8% of those above £250,000, were converted to an annuity.

There is also an element of consistency with those not taking advantage of their rights to a Guaranteed Annuity Rate (GAR). Typically these often provide an annuity rate of 10% or more for those aged 65; this is around twice the best rates currently available.

Overall, the number not taking advantage of this offer was 57% – an alarming rate. However, in the range £30,000 to £100,000 it drops to around 36%. For those below £10,000 the percentage rose to 84%. Did the majority of those cashing in believe an income of up to £1,000 was not worth that much to them? Additionally, the right to a GAR was ignored on nearly 50% of policies above £100,000. Is it because they believe that an invested solution will produce better returns than available on the GAR or do they have other reasons?

‘Two parallel universes’

There appears to be two parallel universes here. The headline number is that 51% cashed in their pensions but deeper analysis shows 87% of these were for pots below £30,000. Nearly 60% of the total pots cashed in were under £10,000.

A third of pots accessed, or two-thirds of those who did not cash in, used income drawdown. A third of those going into income drawdown did not seek advice, and of those 42% had pots worth between £10,000 and £30,000. However 78% with pots above £100,000 did.

A third of those in drawdown withdrew 8% or more of their fund. This is more than double what is recommended if an inflation-proofed income is going to sustain for a lifetime. However again, deeper analysis shows the smaller the pot the greater the number who may be taking excessive withdrawals – above £250,000 the number is 10%; but below £10,000 the number is 68% and between £10,000 and £30,000 the number is 54%.

This data does not give any reasons why, but pots of this size are not being used to provide lifetime income. For those with smaller pension pots we do not know what else they have. Does the pot exist in addition to a DB pension being used to finance early retirement? Is one DC pot being run down before another, larger pot, will be used for retirement income? This may be the case, but these are likely to be exceptions. If the average pension pot at retirement is below £50,000, the above numbers give some interesting pointers to the future.

£30,000 pot is not enough

Thanks to auto-enrolment the numbers retiring with small and moderate pension pots will grow rapidly, but there is no reason to believe their behaviour will be any different from those with current small pots. We are undoubtedly seeing a change in behaviours post-pension freedoms; those who have pension funds below £30,000 do not behave as conventional pension savers. Auto-enrolment has introduced nine million new pension savers but it will probably take 15 years or more before they can retire with pension savings of £30,000.

However, £30,000 equates to no more than £1,500 a year lifetime income in retirement. Add that to £8,500 State pension and you are far short of the £14,000 a year the Resolution Foundation believe to be the minimum income required in retirement to avoid poverty.

For those who are homeowners there will be a need to think (at the very least) how best to use their moderate pension savings alongside their housing wealth to meet their living needs. The latest pension data therefore shows that the demand for later life lending is likely to grow for many years to come.

Bob Champion is Chairman of the Later Life Academy (LLA)