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A new start may be only solution

It seems unlikely that saving for retirement has any easy solutions. It is time to look again at how some additional savings could be invested profitably.

We know that UK productivity is lower than almost anywhere else in the industrialised world. Little meaningful research has been conducted to establish why. I believe that it is in part the effect of excessive interest rates and pressure to provide non-state pensions funded by dividends. Thus, capital-intensive industries, which tend to be efficient relative to labour, have migrated elsewhere.

Public services have suffered from persistent under-investment. These could be provided with capital, either through a higher Government borrowing requirement or in the form of deferred-income bonds which could provide an income at retirement on terms which would be attractive to hold as a retirement fund.

Thus, capital could be supplied for essential public services which, if properly funded and supplied, would improve UK efficiency.

Does it really matter whether the pension burden falls on the state or on commercial enterprise? Either way, it is a national liability. If, however, that liability prejudices the wellbeing of commerce and industry, resulting in an ever declining traded goods sector, what was the advantage of shifting the burden from the state to the non-state sector?

The present regime is unfair, with an inadequate state minimum pension. The present low state pension discourages people from saving a little for retirement as, by doing so, many will lose minimum income guarantee benefits which can top up the state pension income.

The current regime is little better than the old one. The self-employed cannot be in the state second pension as they were barred from Serps. Tax relief on pension contributions paid by the self-employed is very poor unless subject to higher-rate tax relief. Tax reliefs arbitrarily provide most relief if paid by the employer on account of National Insurance savings. It has to be said, why should you save into a plan which gives an element of tax relief now but takes it away in retirement when you are least able to afford the tax? The effect on age relief thresholds is a further disadvantage.

Consider also the loss of control of your savings. The mortality gamble, the inflexibility of the very idea of annuities and the present drawdown schemes and the final loss of capital if you if die the wrong side of 75 all make pensions even less attractive.

The fact that there is a double taxation on pensions in drawdown plans is iniquitous and seldom recognised as the dividends on the investment in the plan are taxed at 20 per cent and then the entire plan income proceeds taxed again at the marginal rate of tax.

Why not start from scratch and create a regime which might perhaps have to include an element of compulsion but which would enjoy a level of fairness and support from the investing public?

All contributions should be made payable out of taxed income with no tax relief to the employer. They should be subject to, say, a 25 per cent uplift by the state, this being the same for any form of pension contribution. This way, a nice level playing field is created.

All pensions will be the direct property of the policyholder and all occupational schemes will vanish apart from the group stakeholder plans sponsored by the employer. However, the contributions will be made by direct deduction from the employee and will not be tax allowable against business expenses, because now the employer pays the contributions to save on NIC for both employer and employee and corporation tax.

The benefits of this plan, with its direct 25 per cent Government subsidy, will be available not before age 60 unless ill health forces early retirement.

As EU rules will almost certainly preclude the reinstatement of pension fund dividend tax relief, reinstatement may not be possible at the hands of a more responsible Chancellor.

The proceeds of the plan could be enjoyed at 60 or over, with the income taken totally tax-free. However, the present tax-free cash can remain and the balance be taken as an income stream. In all cases, the income will be based on the consumption of the capital over Government Actuary&#39s Department life expectancy rates at retirement time. All benefits will be transferable between surviving spouses. Any money left in the fund on the death of the pensioner or spouse will be left in trust if required, free of any inheritance tax.

The capital in the pension fund should be accessible for medical treatment at any time where the NHS refuses to provide essential medical treatment costing over, say, £2,000. The fund will be totally protected from creditors.

This would actually be very tax-efficient and very fair, offering a flat-rate level of subsidy which would be universal. It would provide genuine personal pensions under the control of the policyholder from first premium payment to death. It would remove all the nasty decisions to be made at retirement and then at 75. It would encourage saving and avoid the risk of saving carefully and then losing all the hard-earned savings through premature death.

It is simple, universal and does not favour any one regime of employment. It removes the costs of actuaries. It saves employers from the risk of FRS17. It removes the cost of funding public sector pensions from the state. It frees up money for investment in industry (provided that homes can be found for that investment). It gives people real control over their pensions. It discourages premature retirement other than on health grounds. It allows the less healthy to leave their fund to their heirs. It will be a useful IHT planning opportunity. It removes the problem with the present regime which dishes out 80 per cent of tax reliefs to 20 per cent of the population.

It will also remove the arbitrary disconnection between benefits and premium payments. It will remove the arbitrary variation in the true value of defined-benefit schemes which benefit the married member, via the surviving spouse benefit, at the expense of the single member.

It may be that the amount which can be placed in the plan will have to be limited to a certain level, perhaps a flat figure totally disconnected from income level. Let us say, for example, that the maximum level of funding should be an amount which is likely to provide half of the national average earnings.

The only regular calculation which would need to be carried out is a triennial assessment to establish if it seems likely that the amount being invested in the plan is likely to exceed greatly the benefit maximum expected at retirement. This would be carried out with a simple standardised calculation based on data and assumptions about earnings, inflation and investment returns in a program under direction of the GAD.

The scheme should be sufficiently flexible to allow big investments early on in life, assuming that a policyholder wishes to fund the pension early. If it appears that this is likely to cause overfunding, then contributions might have to stop. If overfunding does happen, the surplus invested should suffer marginal income tax rates at vesting.

Such a scheme is simple, certain and totally fair. Any other saving for retirement can be topped up with Isas, which, of course, are also quite attractive but suffer from not being in trust, while capital is subject to IHT on death.

One feature is certain – they will be very cheap to run and there will be no risk of a trustee going to jail and no risk of another Maxwell debacle. No firm will find itself suffering from the double whammy of an underfunded pension fund at the same time as profits vanish because of a recession. Also, the pressure from pension fund managers, to press the directors of the companies with which they hold their investments to provide ever-increasing dividends may be reduced. This could reduce the harmful impact of Chancellor Gordon Brown&#39s 1997 Budget seizure of pension fund tax relief.

But I suspect the real advantage is that Joe Public might like it. It will not be a panacea which will magically shift the cost of pension funding to the private sector from the state. Remember that the poor do not save because they do not have surplus income. Compulsory contributions from employers will help to destroy the last few jobs in manufacturing (and the jobs in call centres which have not been exported to India).

Pension funding must be considered as part of the overall economic picture. That is known as joined-up thinking. Realistically, the state will always have to accept much responsibility for the wellbeing of the elderly.

If we have to provide an income of, say, £10,000 a year for a pensioner age 65 with a spouse of 60, where the pension falls by a third on the first death but increases in line with RPI, the sum required to achieve this is £200,000 at August 2002 figures. Yes, this has to be the target sum for a normal retirement date of 65. For a couple aged 70 and 65, it is £160,000.

If we have seven million pensioner couples at any time, the total sum invested in pensions will need to be in the region of £1,400bn. Consider the size of the total stock, bond and gilt market as well and there seems to be a credibility gap. The income from such a sum would be about £80bn a year at today&#39s prices.

Some number crunchers need to look at this. Maybe they can find a way of making the figures work but I cannot. If there is a way of absorbing all this capital, investing it to provide a real return, doing so without creating an economic collapse by oversaving, as the Japanese did, saving so much without causing people to starve or be homeless and to do it in such a way that Government revenue from consumer spending does not collapse, then I invite the economic number crunchers to show me where I am wrong.

I hope they can because, if so, as an IFA, I can with clear conscience know that I shall not be misselling pension plans if I persuade everyone I ever meet to make this their target retirement fund, at today&#39s prices, of course.

Assuming that we have just 2 per cent inflation over the next 40 years, a 25-year-old saving for retirement in 40 years will need to build up a fund of £433,000 just to maintain today&#39s standard of living expectations. That is assuming that interest rates do not fall further, so aggravating the annuity rate problem.

One final wicked point. The Treasury must be rubbing its hands with glee about the increased demand for annuities, the reduced supply of gilts as the public sector borrowing requirement falls further, thus combining to further reduce the cost of service the National Debt. No wonder it is against the delay of annuity purchase after 75.


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