BLOG: Pensions and politics – a wolf in sheep’s clothing
Revolution has replaced evolution and people have been given much more freedom over what to do with their pension pot in the decumulation stage. Yet the future direction of travel is not clear and current proposals suggest a wolf in sheep’s clothing.
No political party has clearly spelled out its intentions in the pension space. In fact, the little that was said within the manifestos seems to be dissuading people from saving and investing, rather than encouraging them to do so. At first glance, most proposed measures seem to target the very highest earners. Yet if you scratch under the surface you will see that politicians are slowly scraping away at the pensions savings of millions of hardworking and prudent people.
Let’s take a closer look.
The Lifetime Allowance
There has been a lot of talk about lowering the lifetime allowance. This is already set to decrease from £1.25 million to £1 million in April 2016, meaning that any pension income generated from a lump sum in excess of £1 million will be taxed at 55 per cent (or 25 per cent if taken as a pension – and this is in addition to the income tax you’ll pay when receiving your pension income). While savings of £1 million may sound like a big number, it is not just ultra-high earners that are affected, particularly if the allowance threshold reduces further to £750,000 as suggested by some political parties.
To put this number into context: A pension pot of £1 million today would buy a 60 year old retiree an index-linked annuity income of £25,480 per annum and £750,000 would buy £19,110 per annum. So doing the maths quickly reveals that what seems like a large aggregate sum of money translates into a retirement income a few thousand pounds below the average UK wage. Chipping away at the lifetime allowance sends the wrong message to eager savers seeking to do the right thing – “invest more and you’ll be penalised.”
Contribution tax relief
Cutting the tax relief on pension contributions is another wolf dressed in sheep’s clothing. Pension tax relief costs the exchequer around £35 billion every year. Of this, additional rate taxpayers (those who earn more than £150,000 per annum) receive about 15 per cent, despite the fact that, at around 1 per cent of earners, they represent the smallest slice of the working population. By contrast, basic rate taxpayers, who make around 50 per cent of total pension contributions, benefit from only 25 per cent of the total pensions tax relief, according to the Pensions Policy Institute (PPI). It is not surprising that politicians are looking at restricting the tax relief for those on the highest incomes and using the savings to cut tuition fees or raise the inheritance tax threshold instead. The problem is that I very much doubt it will stop there.
Indeed, there has been talk about introducing a single rate of tax relief that would apply regardless of the marginal tax rate, with suggestions ranging between 27-33 per cent. Currently, basic rate tax payers receive tax relief at 20 per cent, higher rate payers receive 40 per cent and additional rate payers 45 per cent. Earlier this year, the politically agnostic PPI suggested that a tax rate of 33 per cent would be tax neutral, in that no matter who wins the election the measure wouldn’t cost the exchequer any more or any less. Politicians say a single rate of tax relief would make the system fairer. What it also means, however, is that those 15 per cent of the working population who pay higher rate tax, around 4.5 million people, would be penalised.
Pensions have become a soft target
In short, pensions have become an easy target for politicians. A plethora of jargon, a lack of clarity and complex structures make it difficult for people to understand and analyse the proposed cuts. While on the one hand all of the political parties claim to focus on creating a long-term savings culture, on the other they are creating uncertainty with talk of yet more tinkering with lifetime allowances and suggestions of capping tax relief.
The biggest strategic imperative in the UK is to get the nation investing for retirement and that’s where we should focus our attention. Even our own House of Lords suggested in 2013 we are the world’s worst for pension saving, reflected in the fact that we have the lowest replacement ratios in retirement across the OECD for the average earner.
What we need is an Independent Pensions Commissioner – somebody of Lord Adair Turner’s or Ros Altman’s ilk, an independent and strategic thinker operating outside of politics, who can take big strategic pension initiatives forward and help the population secure good financial outcomes in retirement. While getting the nation investing for retirement through conventional and less conventional means should be the principal focus, early stage engagement, easier access to professional advice and the provision of guidance at and through retirement run a close second.
I really hope that whoever wins the election in a few days’ time will come to the same conclusion.