Hornbuckle Mitchell's Stewart Dick says that to today's pensionholder, the idea that you can control how and where your retirement savings are invested is pretty much taken as a right. In fact with over 900,000 Sipp plans now in place, investors could be forgiven for taking the choice, flexibility and transparency they offer for granted. But a look back at the history of personal pensions over the last 50 years or so shows just how much things have changed with individual pensions evolving from the steady but basic Retirement Annuity Contracts (RAC) to today's super-flexible Sipp products.
We have become so used to choice, transparency and competition that it is hard to imagine just how limited the options were back in 1956, when the RAC first arrived. In the decades that followed the economy became more sophisticated, consumers became more demanding and governments sought to instill a sense of personal responsibility for retirement income in the public. Sipps have thrived in this environment with their almost unlimited degree of personal control and great degree of flexibility. Competition has also brought down costs. Mr Dick says planners who want to know where Sipps are going need to understand their past and their roots. His article provides a timely look at the timeline for Sipps as they prepare for further change under the RDR and regulatory influence.
To the modern financial consumer, the idea that you can control how and where your retirement savings are invested is pretty much taken as a given. In fact, with over 900,000 Sipp plans now in place, investors could be forgiven for taking the choice, flexibility and transparency they offer for granted. But a look back at the history of personal pensions over the last 50 years or so shows just how much things have changed, evolving from the steady but basic Retirement Annuity Contracts (RAC) to today's super-flexible Sipp products.
We have become so used to choice, transparency and price competition that it is hard to imagine just how limited the options were back in 1956, when the RAC was first introduced. You had to be self- employed, or not have access to an occupational scheme to take one out, contributions, which were tied to earnings, were strictly limited, investment options were few and there was no tax-free cash. And when you came to retire you took the annuity you were given. Introduced just two years after the end of food rationing, savers in those first RACs were doubtless used to a lack of choice. But in the decades that followed the economy became more sophisticated, consumers became more demanding and governments sought to instill a sense of personal responsibility for retirement income in the public. Personal pensions had to change if they were to remain relevant.
The evolution of pensions has been a story of a steady, if at times slow, trajectory towards greater transparency, flexibility and choice. The fortunes of the economy in which savers' assets have been invested on the other hand have been considerably more mixed. In fact many of the key developments in the legal and tax structures in which pensions operate have come at times of economic crisis.
Small self-administered schemes (Ssas) were introduced at the height of the 1970s oil crisis, Sipps first saw the light of day just as the economy was slipping into recession in 1990 and flexible drawdown became possible in 2011 between the double dips. More positively, personal pensions were born in 1988 as the stock market was coming back from its Black Monday depths, while the sweeping changes of A-day were instigated in 2006 in those halcyon days when some still believed boom and bust had been abolished forever. But whatever the economic backdrop, since the system was liberalised, investors and their advisers have grasped the opportunity for more flexible pensions with both hands.
For 15 years after their introduction in 1956, RACs made only a limited impression on the nation's long-term savings habits. But that was to change in 1971 when Conservative Prime Minister Edward Heath increased contribution limits from 10 to 15 per cent, with the overall limit doubled to £1,500. If that doesn't sound much, it is worth remembering that back then the average wage was about £2,000 a year and the average home cost £5,600. 1971 also saw the introduction of the tax-free lump sum, an option that remains one of pensions' most attractive features to this day.
Two years later, just as the Middle East oil crisis was tipping the economy into a downturn that would wipe 73 per cent off the value of the UK stock market, the Finance Act 1973 introduced the ability for controlling directors to join occupational schemes, thus creating the Ssas. Crucially, these first Ssas plans, which had between one and 12 members, pioneered the concept of giving individuals direct control over the investments in their pension scheme. This notion that individuals might actually have a right to control how and in what their retirement savings were invested was to prove pivotal in the development of personal pensions. The next stage in the liberalisation of the pensions system was the freedom to transfer funds from occupational schemes into personal plans, brought in during the early 1980s.
But it was in 1988 that the modern era of retirement saving truly arrived with the launch of the personal pension, which linked the plan to the individual rather than their employer, allowing individuals to take their pension with them when they changed job. The new rules around contributions into personal pensions were more flexible and, importantly, providers did not have to be insurance companies to offer them.
The end of the 1980s was another significant period for the development of pensions, with the Thatcher government striving to instill a sense of personal financial responsibility in the population. It was in then chancellor Nigel Lawson's 1989 Budget speech that the concept of the Sipp was first introduced, when he pledged to "make it easier for people in personal pension schemes to manage their own investments." A year later the first Sipps were launched, although their initial impact was dampened by contribution limits, capped at between 17.5 and 40 per cent of earnings - half those permitted into Ssas arrangements. And as if that wasn't making life tough enough for Sipps, investors in Ssas plans were also allowed to take more tax-free cash.
It was to be another six years before Sipps were given the chance to be able to truly fulfill their potential, with the introduction of the ability to exercise income drawdown, a freedom already available to personal pensions that was extended to self-invested arrangements following a campaign from advisers and providers. The idea of managing one's investments through retirement, accessing a broad choice of asset classes, stood in stark contrast with the dismal thought of being stuck with a lacklustre annuity from a life insurer, and the Sipp market finally achieved lift-off.
Sipps were to get a further boost at the turn of the millennium, when the growth in the internet fostered the growth in low-cost online 'supermarket' Sipps. Supermarket Sipps did not give access to the complete range of investment asset classes as 'true' full service Sipps, but their popularity in the media certainly helped spread the message about the attractions of self-invested pensions among the public. That surge in interest in freedom, flexibility and choice was followed up with the 2003 launch of the Revenue's landmark Pensions Simplification consultation, which promised to tear up the rule book, sweep away eight layers of regulations and create a completely new tax structure. This was a consultation that can justify the claim of having started with a blank piece of paper, with fine wine, art, classic cars and even residential property on the menu as a potential asset class for tax-advantaged retirement saving. The media lapped up the idea, and although the freedom to invest in these asset classes never made it to the statute book, the consultation put personal pensions, and Sipps in particular, on the front page of national newspapers.
Despite ultimately holding back on residential property and investment exotica, the new pensions taxation system, introduced on A-day, 6th April 2006, can still be described as truly revolutionary. Both occupational and personal pensions were swept into a single set of rules that granted an individual a lifetime allowance of tax advantaged pension saving, fixed at £1.5m for 2006/2007. Annual contributions were equal to earnings up to a massive £215,000, and for the first time people in occupational schemes were also allowed to save in personal pensions, a development called 'concurrency' that gave employees much greater choice than the AVCs that had been their sole option previously. A-day also introduced the freedom for anyone over 50 to take a quarter of their fund tax free whether they stopped working or not.
All these factors combined to give a massive boost to the Sipp industry. But the one fly in the ointment was the introduction of the deeply unpopular Alternatively Secured Pension (ASP) phase for those who remained in drawdown after age 75. ASP's tax charge on death of up to 82 per cent was to become a focal point for criticism of the way the system effectively forced people to buy an annuity at 75. Thankfully for Sipp investors, that criticism culminated in the abolition of ASP and its replacement with two options, capped and flexible drawdown, the latter allowing the individual to withdraw their entire fund as cash, subject to tax, provided they could prove they had a secure income stream of £20,000 a year.
But while flexible drawdown has removed the age 75 annuity headache for retirees, last year's changes also had a downside for drawdown investors with the reduction in withdrawal levels from 120 to 100 per cent of Government Actuary's Department limits. This restriction, compounded by historically low gilt yields, has choked the retirement income available to some drawdown investors by a quarter or more. Thankfully those saving in Sipps with a scheme pension facility have been able to escape the worst of these changes by making withdrawals at a rate approved by the scheme's actuary. This means factors relating to the individual's personal circumstances, such as their health and life expectancy, can be more accurately taken into account, often meaning greater withdrawals are possible.
Taken together all these changes have created a retirement savings environment that would be unrecognisable to those first RAC investors. The next half century will doubtless see as much change, both in attitudes to saving and in the structure of the savings framework, if not more. Take flexible drawdown, for example. Barely a year old, the concept seems new and perhaps daring to advisers and investors, yet a decade from now it could well be mainstream. Research carried out in 2010 by the Pensions Policy Institute predicted that around 200,000 people between the ages of 55 and 75 will have sufficient pension income and DC pension savings to use flexible drawdown, rising to 500,000 by the time they reach their state retirement age. And the PPI also predicted that these numbers will increase in the future as fund sizes grow.
And the future will hold other changes for the world of pensions as demographic, economic and political factors continue to shape it and clients demand ever greater freedom and choice. Perhaps the only certainty is that freedom, control, transparency and choice that have nourished Sipps will continue to be the drivers of the pensions environment of the future.
Tuesday, 24 July 2012 15:16
Technical Update: History of personal pensions
In this edition of Technical Update we look at the history of the Sipp market from its origins as a small, niche sector to today's rapid growth with over 100 providers.