Industry research consistently finds that customers don’t understand pensions and find it all a bit complicated.
And while education and engagement needs to play a role, we also need to make things much simpler.
Isas are generally recognised as being quite simple as there’s a single and simple set of rules that apply to everyone.
The Lifetime Isa, on the other hand, is more complex because it’s not been designed to benefit everyone and the recent FCA consultation paper highlights the quite complex considerations in matching this product with only those customers for whom it’s intended.
Pensions face a similar challenge to Lisa because there are certain groups of people for whom putting money in to a pension is not optimum. The lifetime allowance causes this problem.
Removing the Lifetime Allowance in isolation could see more tax relief benefiting the most affluent than is currently the case and this would be unpopular with the electorate.It’s a very small percentage of pension savers, but the negative impact on outcomes at retirement is being felt by everyone.
Whether we stick with the term 'pensions' or rebrand this in the future, we need employers, providers, advisers, and the government to get behind a simple and impactful message which applies to everyone.
The moment we introduce small populations of people for whom the message doesn’t apply, the game is up from an impact perspective due to the complex caveats which need to be introduced.
The current tax system allows wealthy investors to save up to £40,000 a year into a pension. The term ‘tax relief’ is used, but that is a bit misleading as this is really about tax deferment and those with the most money to save tend to be the oldest workers for whom the period of tax deferment can be quite short.
There are, of course, some tangible benefits for those who drop a tax band in retirement, and only 75 per cent of pension savings are subject to taxation in retirement.
Where the system shoots itself in the foot is in investment growth. Industry research currently shows that returns of more than 8 per cent compound are being achieved by many default funds over one, three and five year horizons.
Let’s therefore consider two examples:
1. A saver who has accumulated £1m at age 50 and who intends to retire at age 60 currently looks to invest in something that offers a zero return in order to avoid a penal tax charge at retirement. At age 60 they retire and choose to draw down 4 per cent of their pot, giving an annual income of £40,000, on which they pay basic rate tax. They purchase things with that income on which VAT is paid. The people who sell them those goods and services receive income on which they pay combinations of income tax and corporation tax. They, in turn, then spend their earnings and profits and so the virtuous economic circle continues.
2. Had the saver been able to benefit from continued investment growth at 8 per cent a year (and assuming no further contributions or tax relief on contributions) the pot at age 60 would be £2.16m. Once again, assuming they draw down 4 per cent of their pot per annum, this gives an annual income of £82,000. The retiree would then pay a higher rate of tax on twice as much money, to the benefit of The Exchequer and society. The retiree would have the capacity to spend twice as much on goods and services on which VAT is paid. And those selling the goods and services would receive twice as much income on which a combination of personal tax and corporation tax is paid.
The assets in our pension system are an important national asset, supporting investment in British businesses, housing and infrastructure.
The Lifetime Allowance, however, means that an increasing proportion of pension pots are required to become economically unproductive, as savers who reach the £1m threshold have to switch investments away from anything that might offer them a return.
For those who breach the Lifetime Allowance the situation is more challenging. Maybe the German government could come to the rescue with their two-year Bund currently offering a yield of -0.74 per cent.
A theoretical consequence could therefore be that UK savers need to take money out of assets which invest in British industry and infrastructure and give these to Germany to bank roll their economy instead. It’s a prospect that doesn’t seem all that patriotic.
While the Lifetime Allowance is problematic, it was introduced as part of a suite of measures to target scarce resources towards those who have the greatest need.
Removing the Lifetime Allowance in isolation could see more tax relief benefiting the most affluent than is currently the case and this would be unpopular with the electorate and be generally unfair from a social justice perspective.
If and when the government again considers our system of pension taxation more broadly, removing this particular ingredient in conjunction with other appropriate measures could result in a system which is more easily promoted and understood by the public and remove undesirable and irrational economic consequences from the system.
Pete Glancy, head of industry development, Scottish Widows