Building a sustainable pensions framework

I would still welcome a moratorium. However, if the government has not reached a position where it feels the pension framework is sustainable, I would prefer it to shake the tree rather than constantly pick away at the low-hanging fruit. This with a view to ensuring we have a sustainable system, free from political interference for long enough to restore a bit of faith.

If the government were to commit to a review, the seven changes I would suggest would be:

1. Lifetime allowance

When the annual allowance and lifetime allowance were introduced in 2006, the latter was the government’s main control on the level of pension saving. In reality, an AA that exceeded £200,000 was not really a control, nor was the cost of the tax relief sustainable.

With the AA now set at a level that the government appears to feel is fair and sustainable, the lifetime allowance becomes irrelevant and is simply a tax on investment growth.

The ever-growing list of transitional protections needed to maintain the lifetime allowance are a needless complexity which make pensions more expensive because of the time spent by providers dealing with and explaining them.

2. Drawdown rules

Drawdown suffers from a number of problems linked to the outdated belief that it is a means to defer the purchase of an annuity. In reality, drawdown is now used as a product in its own right and the rules that govern it should reflect this.

The greatest flaw with the way the maximum pension is set is the link to Gilt yields. The measure is not representative of the investment holdings of Sipp investors, and is a poor indicator of the potential for future investment growth.

My own proposal is centred on simple age-based limits where someone can take a maximum of 5 per cent of their pension in their 50s, 6 per cent in their 60s, 7 per cent in their 70s and so on. Improving certainty in maximum income will allow savers to plan more effectively.

3. Flexible drawdown

The number of people taking up flexible drawdown has fallen massively short of expectations. The primary reason for this is the complexity of the rules, which has stopped providers from offering the facility and meant that savers have struggled to understand where and how they can access flexible drawdown.

Although the current regime has failed, it does make sense to allow individuals who are unlikely to need to fall back on the state for benefits in retirement to access a higher proportion of their pension.

I would, therefore, propose a simpler system, allowing individuals enhanced access to their pension (though not the whole fund) provided they can meet simpler access requirements.

I would allow a maximum pension of 10 per cent of a drawdown fund that exceeded a value of £200,000, with the safety net of the capped maximum if the pension falls below this threshold. This offers the government the security it requires but allows access to a greater number of savers.

4. Sipps

Before A-Day, the Sipp industry and investors benefited from the security blanket of a permitted investment list. Since A-Day this has not existed.

It is not a coincidence that since A-Day, and in particular since 2008, we have seen a steady stream of failed investments, principally promoted through Sipps.Where investments are not covered by the Financial Services Compensation Scheme investors have lost their pensions. Where compensation has been available we have seen huge expense to the government and the financial services industry.

It seems obvious that a solution to the problem is to re-introduce a permitted (and prohibited) investment list. This will be difficult for HMRC, and to a lesser extent the FCA, when the post A-Day pension world is defined by whether actions are taxed or untaxed, rather than approved or prohibited, but the amount of investor funds we are talking about means difficulty is not an excuse.

5. Lump sums on death

I have successfully lobbied regarding cliff-edge tax rates applied to lump sum death benefits in the past. However, while the current rules are an improvement on the old 82 per cent tax rate, they are still far from perfect. We have moved from two cliff-edges (35 per cent on crystallising funds and a further 47 per cent on reaching age 75) to one of 55 per cent.

Cliff-edge tax rates drive tax avoidance, in this case typically involving the use of qualifying recognised overseas pension schemes or overseas annuity products. HMRC has taken steps to stem the improper use of Qrops in recent years but we are not there yet.

It is going to prove near impossible to close every tax loophole, so an alternative option would be to remove the cliff-edge incentive to avoid tax.

My suggestion is simply to apply a 35 per cent tax charge on all lump sum death benefits -uncrystallised and crystallised. Not overly generous where the deceased died before crystallising or overly penal where they die after crystallising.

6. Early access

Pensions liberation fraud is typically attempted by individuals in their 40s or early 50s. They have had sufficient time to build up a reasonable pension fund, but are not yet entitled to receive a pension or lump sum. The difficult financial circumstances which many families find themselves in at present means many are being tempted by the apparent opportunity to unlock their pension.

One way of dealing with this issue would be to allow early access to the pension commencement lump sum. I would not allow early access to the whole fund as the pension element needs to be protected. It is typically the part of the fund that keeps individuals off state benefits in retirement. The tax-free lump sum can be spent once received, and so may not contribute towards an ongoing retirement income. I would limit access to the pension commencement lump sum to those aged over 45.

7. ill health lump sums

The serious ill health lump sum allows individuals with less than 12 months to live to access their entire pension to support themselves. It is only available to individuals who have not crystallised any of their pension. Once the pension has been crystallised a serious ill health lump sum can no longer be paid.

The policy is designed to reflect the way that death in service lump sums are paid from defined benefit schemes, which again shows why a review is needed. Pension policy design in the 21st century should not be based on building equivalence with a part of the pension system that began to become obsolete before the end of the 20th century.

This is another cliff-edge that we need to remove. It is not right that a benefit of immense value to terminally ill pension holders is completely switched off at the point that a pension is crystallised.

Since writing to the Treasury with these proposals I have had a number of interesting debates concerning individual points. It is worth emphasising that I see the key as being the principle of sustainability, rather than any one of the proposals.We need a period where we have confidence that the rules governing pensions are stable. If the government does not feel we have reached that point, a single review must be better than death by a thousand Budget cuts.

Andy Bell is chief executive of AJ Bell

Key Points

* The ever-growing list of transitional protections needed to maintain that lifetime allowances are a needless complexity which make pensions more expensive

* The number of people taking up flexible drawdown has fallen massively short of expectations

* One way of dealing with the issue of pension liberation fraud would be to allow early access to the pension commencement lump sum