Guest Blog AJ Bell 150pxIn his first guest blog for us, Mike Morrison Head of Platform Marketing at SIPP provider AJ Bell, looks at the latest call for changes to the system of pension tax reliefs and tax-free lump sums.

You go away for a couple of weeks holiday in the summer thinking – it’s summer, it’s hot, we are winning sporting events and there is a royal baby on the way. Surely pensions will be low on the agenda, at least for a few weeks?

So pretty much on the first day away, browsing the internet to find out the cricket score, I see new pensions headlines – I nearly choked on my sangria!

Pensions tax relief and the tax-free lump sum, the old perennials, now being questioned in a paper by the Pensions Policy Institute (‘Tax relief for pension saving in the UK’), as they had been last year by the Centre for Policy Studies.

Mike Morrison is Head of Platform Marketing at AJ Bell

Mike Morrison

So here we go again. We’re told we need to reconsider the tax incentives for pension savings, as the distribution of tax relief is disproportionately skewed to those who pay higher rate tax in employment and then only basic rate tax in retirement. Similarly, the provision of a lump sum has also benefited those with larger funds and the most tax relief.

Pension reports & surveys

The report looks at a single rate of tax relief going forward, restrictions to the lump sum and the effect of the recent changes post A-day (introduction of the lifetime allowance and the annual allowance).

These arguments and discussions will continue as they always have but, as is usual, it is the timing that puts the discussion into context.

The recent ‘ONS Pension Trends 2013’ showed that membership of occupational pension schemes was at its lowest since the 1950s, and 65% of this low membership are in public sector schemes.

A recent survey for Aegon has shown that some 30% of people over age 55 do not have active pensions, and that 36% of those between 16 and 64 also do not.

Another survey from LV (somewhat bizarrely) suggested two million pensioners have less disposable income that an 11 year old child!

Even with the ongoing auto enrolment process, the underlying caveat is that the prescribed level of contributions will not be enough to live on – they will need to be supplemented.

Looking at it from another perspective, the OECD has recently questioned the effect of an ageing population on the UK benefits and state pension system, suggesting that the pressure put on it might not be sustainable.

[A further finding of the Aegon survey was that more than half of 25 to 34-year-olds believe they will retire at the age of 65 or under, even though the state pension age will rise to 66 in 2020 and 67 in 2028! Further evidence of a lack of engagement?]

So what can we learn from all this? My take is this – it costs us lots of money to incentivise pension saving, and it does not work efficiently. On the other hand, it will cost us lots of money in the future if people have not saved and need to rely on the state for benefits.
The two are linked!

The introduction of the annual allowance and the lifetime allowance in 2006 started the route to limiting tax-privileged pensions funding, and the longer we go on the more people will cease paying in to protect a lifetime allowance.

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The concept of only paying tax once (so tax deferral and the EET concept) also seems logical – particularly if, in the widest sense, ‘pensions are pay’.

Problems and questions

Pensions have been something of an easy target and often the victim of short term thinking – today’s Government will seek tax today without a consideration of the long term consequences and costs tomorrow – it might not be their problem!

Surely, before we make any more changes it would make sense to look at some of the big questions:

  • What is the relationship between the cost of incentivising pensions and the reduction in cost of benefits if such incentivisation works?
  • Should the tax incentive be limited to a certain amount that the ‘state’ should provide in order to keep individuals off state benefits – perhaps £20,000 p.a. as with flexible drawdown? (As part of his 2013 Budget, President Obama has proposed to limit the amount of money a person can accumulate in all tax-advantaged retirement plans – the limit is $3 million, or the amount that could be used to provide an income of $205,000 p.a. at age 62, increasing in line with inflation – a conversion rate that could also change with actuarial assumptions and interest rates.)
  • Today our £1.5 million lifetime allowance would buy an income of about £42,000 p.a. (RPI linked male 65, female 60, 50% widows pension) and that will decrease even further when we move to £1.25 million and if/when annuity rates worsen.
  • As life expectancies increase, there may be a need to increase the tax take from pensioners, as there will be fewer tax payers below state pension age. Is there an argument that higher earners in retirement will mean higher tax receipts for the Treasury?
  • The current tax incentives work differently in Defined Benefit (DB) schemes as opposed to Defined Contribution (DC) schemes. There is always a somewhat jaundiced view of changes that affect DC more than DB, because the latter are predominantly public sector schemes, and are seen as a real perk.

Aside from the above (and other questions besides) the Holy Grail must be to create a savings culture where individuals are fully engaged with savings and retirement, understand what they will need and how incentives work.

Let’s get this right before we do even more damage!

[I have not covered the proposals for the tax-free lump sum – abolition or limitation would be a real mistake. In the first instance I would like to see proposals to dismantle the public sector schemes’ provision of a lump sum – although I think any Government would find such changes a real vote loser!]

Mike Morrison is Head of Platform Marketing at AJ Bell.