It seems to politicians, pension changes are the equivalent of a box of Maltesers – they just cannot resist one more. The sweeping changes to the retirement landscape have not even been introduced yet but already politicians from all parties are talking about the next significant alteration. The odds-on favourite appears to be changes to pension tax relief, as well as possible further restrictions to annual and lifetime allowances.
And this is not a new phenomenon. Ever since the “once-in-a-lifetime” pension simplification was introduced at A-day in 2006, we have had significant changes come up every year.
High annual and lifetime allowances to give people freedom and flexibility around saving for their retirement were introduced with cross-party agreement in 2006 and increased up to 2010. Since then we have seen massive erosion which may well continue into the future as both Labour and the Liberal Democrats favour further cuts to both allowances.
At retirement we saw a reduction in the maximum income that could be withdrawn through drawdown as recently as 2011, which was pushed back to the original level in 2013. This was then increased further in last year’s Budget in anticipation of no limits from April 2015. Neither of these examples demonstrate any great master plan that considers the long-term impact on pensions. Instead, we have short-term tinkering, which often seems to focus on political considerations rather than the long-term social and economic benefits to our country.
The latest idea doing the rounds is to make changes to pension tax relief. Labour has a proposal to limit tax relief for those earning more than £150,000, as well as reduce the annual allowance to £30,000 and the lifetime allowance to £1m.
One million pounds sounds like a huge sum of money but when it needs to last people for perhaps 30 years of retirement and possibly also help fund long-term care costs, its impact soon diminishes. This size of pot gives a yearly income of just below £32,000, if we assume no tax-free lump sum is taken, income increases in line with inflation, with two-thirds continuing to a partner on death. If 25 per cent tax-free cash is taken, the income would be around £24,000 a year. This is undoubtedly a good pension that many of us would be grateful to receive.
But it does demonstrate these measures are not simply targeted at the mega-wealthy. They will impact on “normal” people earning reasonable incomes. People who want to do the right thing by providing for their later life and making sure they are not a burden on the state.
It also exacerbates discrepancies between the treatment of defined contribution schemes – which most employees in the private sector now have – and defined benefit schemes, which are today mainly the domain of public sector workers. Due to the simplistic measure used to value DB pensions, an income of £50,000 a year could be given without breaching the £1m lifetime allowance. Bearing in mind this income is likely to increase in line with inflation and include benefits for a partner, this difference in treatment is substantial – and possibly unsustainable.
Meanwhile, recent speeches by the Lib Dems’ Steve Webb and the Conservatives’ Mark Hoban floated the idea of a new single level of pension tax relief, somewhere between the current 20 per cent and 40 per cent bands.
Flat-rate relief may well be simpler to explain and would hopefully encourage more basic rate taxpayers towards greater pension saving. However, it would be costly and complex to introduce, especially for employers running occupational pension schemes where tax relief is automatically given as part of the employee’s salary calculation.
Rather than continue to make widespread and significant amendments to our pension system, we need a period of stability to work out the impact of the excellent auto-enrolment changes and how that feeds through into long-term saving as well as see how people use the flexibility introduced in April. Only then can we reasonably work out if pension saving in the UK is on the right track. In the meantime, it is time to close the box of Maltesers and put them back in the cupboard out of reach.
Andrew Tully is pensions technical director at MGM Advantage