Generous pensions may just disappear

Depending on what George Osborne says, the Budget could signal the end of occupational and retail pensions as they have been understood in the UK for nearly a century.

The story begins two years ago, when the chancellor shocked the insurance sector by ending the requirement of all but the wealthiest individuals to annuitise defined contribution retirement savings pots.

Securing a guaranteed income for life moved, at a stroke, from the centre of public policy to the margins. The government hailed its new approach as “pensions freedom and choice”, giving all savers access to pension savings from the age of 55.

Revolution is an overused and-much abused adjective but it is appropriate in this case. Sales of annuities collapsed. Thus 74,000 annuity contracts were signed in the first quarter of 2014, before the pensions freedoms were announced. But just 12,000 were sold in the second quarter of 2015, when the freedoms went live. Retirees have fled guaranteed income-for-life products.

Historically low gilt yields, as well as the absence of competition in the annuity market, have driven up the price of annuities. Market timing risk is another factor weighing against their purchase. More widely, retirees simply do not like handing over all of their pension pot. Flexibility and retaining ownership of capital looms larger in the consumer’s mind than guarantees.

The implications for the pensions system are profound. Pensions are usually defined in terms of an employer contribution and particularly advantageous tax treatment provided by the state, in return for locking away savings until retirement, at which point they are turned into a regular income stream.

Mr Osborne’s pension freedoms remove the fourth pillar and erode the third. In itself this is not perhaps decisive. After all, there is no obligation to annuitise pensions savings at any point in the life cycle in Australia or the US. As long as employers remain committed to the system, pensions will survive.

More widely, retirees simply do not like handing over all of their pension pot. Gregg McClymont

But for how much longer? The elephant in the room is the chancellor’s consultation on reforming pension tax relief. The government is floating the possibility of fundamental change. Rather than the generous tax relief on pensions savings as it currently exists, HM Treasury could move the UK to a cheaper and simpler tax treatment, with pensions becoming more like Isas.

No one should be surprised. As the guardian of the public purse, it is hard for government to justify the current generous system of reliefs except as a means to encourage individuals to make greater provision for their own retirement, thus reducing future calls on the state’s resources.

In this respect, the tax relief consultation is a logical corollary of pension freedoms – one which the chancellor is likely to have had in mind when he swept away compulsory annuities in 2014.

But pension Isas are not compatible with the employer-centred system of workplace pensions that has been the objective of public policy since the authoritative conclusions of Lord (Adair) Turner’s Pensions Commission a decade ago.

At the heart of Turner’s analysis was the collapse in employer pension contributions, from about 3.5 per cent of gross domestic product at its height in the 1970s to just more than 1.5 per cent by 2000. His commission sought to rebuild employer engagement and recognised the importance of incentives provided by the current system of reliefs.

Writing off national insurance contributions (Nics) on the employer’s contribution and enabling salary sacrifice encourages employers to offer more than just minimal pensions benefits. Take them away and employers’ responses are predictable.

This is the scenario in which pensions could enter a death spiral. Already scratching their head at providing pensions that can now be accessed long before retirement, the winding up of Nic reliefs and salary sacrifice could prove the final straw for employers.

Pension contributions could gradually fall to the floor set by auto-enrolment (currently 3 per cent) to be replaced by other benefits and/or savings products within the company’s total reward package. Ultimately, with a whisper, not a roar, high quality defined contribution workplace pensions could disappear.

No wonder pensions advocates are holding their breath. Over to you, Mr Osborne.

Gregg McClymont is the former shadow pensions minister and is now head of retirement savings at Aberdeen Asset Management