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Chris Gilchrist: A radical philosophy for toxic pensions

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Once upon a time, pensions were simple. Most full-time employees were members of a good occupational scheme and bosses had schemes that were up to 10 times as good.

During the past 40 years, all forms of pension have become far more complicated. The state has reneged on its commitments, especially the level of the state pension in relation to average earnings and S2P top-ups. For many years it didn’t pay anyone on low earnings to save for retirement because they lost more in state benefits than they gained.

Meanwhile, companies played fast and loose with employees’ pensions. Companies paid too little into their schemes and took contribution holidays, aggravating deficits that have persisted for a decade or more at many supposedly ‘world-class’ FTSE 100 companies. 

But the separate bosses’ schemes – which have steadily got better while employees’ have got worse – never put them at any personal risk.

Insurance companies hard-sold high-charging personal pension plans to people who didn’t have a clue about restrictions on access and penalties if you stopped contributing. The majority of those plans – probably three-quarters of them – have lapsed.

You do not have to think long to realise all this was morally and socially toxic. It fostered a correct perception that the system was unfair and biased towards a lucky few. The insurance companies got away with murder. So did the politicians and the business bosses.

Every attempt to improve things has made them worse. A-day was a disaster, generating a mountain of documentary gobbledegook. Lord Turner’s blueprint for ‘radical’ pension reform – only now becoming reality a decade after being proposed – was in fact just a messy compromise that bought political support from everyone at the price of complexity and incomprehensibility.

Why should anyone be surprised that enthusiasm for retirement savings has dwindled to negligible levels? The only people with any interest in pensions are the fat cats who milk the system, their advisers and an army of consultants who add nothing to what ordinary pension scheme members get.

There is no reason why ordinary people should want to spend their time doing something as daft as trying to plan for a retirement that is 40 years away. So they won’t. It is only if it is done for them on a collective basis, either by the state or paternalist employers, that you can expect people to accept an element of forced savings. It has to be forced savings because without compulsion, there will always be free riders, and the higher the contributions the more of them there will be.

The fiction that auto-enrolment is working is laughable – wait until contribution levels are the necessary 10 per cent and see what drop-out rates rise to. I guess it will be 15 to 20 per cent, and on that basis the scheme will be a disaster.

Plans and proposals that simply repeat the errors of the past or tinker with elements of the failed system are rightly deemed to be insane.

Only radical reform will make a difference – and by radical I mean change on the scale of Beveridge, or Lloyd George’s introduction of the state pension.

Instead, the Government tries to pump up the housing market, which will simply foster the illusion that ‘my house is my pension’ and make the problem harder to solve.

Chris Gilchrist is director of Fiveways Financial Planning, the author of the Taxbriefs adviser guide The Process of Financial Planning and edits The IRS Report

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Comments

There are 12 comments at the moment, we would love to hear your opinion too.

  1. Simple solution: scrap pensions altogether !! and scrap ISA limits !!

    The current system of pensions is about as fruitful and satisfying as playing football with a rugby ball.

  2. We know all this. I’ve already (on several occasions) set out my blueprint for an improved (tax-assisted) retirement savings framework that would address most, if not all, of the offputting aspects of the present one. Where’s yours?

  3. I think Chris is right. It was a mess and has been made even more of a mess.
    Hence why we deal with a much smaller client base now than we did some years ago. We focus on those who are interested and able to save. There is no marketing allowance to “sell” the idea to the mass market.

  4. Christine Brightwell 18th October 2013 at 2:33 pm

    Although pensions may be a mess it is worth remembering that those who have only small pension pots when they retire can commute for triviality. Although this will not provide them with a pension it may well settle some outstanding debts which would otherwise make surviving on a low income even more difficult.

  5. Wider use of pension funds would improve on the now marginal tax incentives (at least relative to ISA) and make benefits more attractive. This might include income protection, long term care and perhaps even pension term assurance !

    Consumers should have the choice of using pension funds to buy insurance or directly draw benefits under qualifying circumstances. It is after all supposed to be their money.

    This would help to differentiate pension saving from ISA, stimulate innovation in the industry and aid Governments to scale down state aid for such benefits.

  6. @ Christine – I agree, we has a lot of low earners at one Group scheme where the employer made a generous contribution back in the early 00’s when the Trivial pension limit was only £2,500. I told them about the trivial limit so that even if they were nearly 60, they could see it was worth entering the pension scheme. The incraese to 1% of the lifetime alllowance or £18,000 was very useful for the younger ones too. What woudl be even better woudl e if they incraesed the trivial limit to 2 or 3% of the LTA or 40k whichever is the higher as the taxman still gets his slice, but the individual gets more flexibility i.e. repay borrowing rather than draw a small pension.

  7. Christine Brightwell 18th October 2013 at 3:03 pm

    Phillip I agree. You cannot get much of an annuity for £40k and the lump sum could make a huge difference to many people, including paying off the tail end of a mortgage for some

  8. Commutation of a trivial pension fund is sick joke (or at least the last couple I’ve arranged were ~ things may since have changed, though I doubt it). Apparently, HMRC insist that providers must multiply by 12 (to annualise it, as if it were income) element of the commuted fund.

    So, what happens is that the provider deducts (and pays over to HMRC) 40% tax and any excess over what should have been deducted (which might well be none whatsoever) is virtually impossible to recover. Ever tried phoning a local tax office for help on something such as this? Either the phone never gets answered or you leave a message to which no one bothers to respond or you get through to some halfwitted bozo who either doesn’t know WTF you’re on about or doesn’t care to make the effort to find out.

    Is it any wonder that people don’t want to lock away money into a pension plan?

  9. Christine Brightwell 18th October 2013 at 6:13 pm

    Julian, do you mean this happenedn respect of a DC arrangement?

  10. @Julian and Christine – That’s the first time I’ve ever heard of that happening Julian, but having looked at a letter from Skandia for a GPP member who claimed direct, it woudl appear HMRC are after allowing payment of lump sum. asking them to apply emergency tax code to remainder and then the member has to reclaim excess tax through their self assessment tax return and if not needing to do one, they then need to ask HMRC direct.
    As Julain says, yet again a barrier to simplicity and extra costs as most of these people have never completed a tax return in their lives having always been PAYE.
    HMRC and the Govt couldn’t make it any more difficult and off putting to save using a pension if they tried.

  11. Hello again Julian and Christine – Just checked technical notes and it is a known problem at HMRC apparently. It still looks like a complete Horlicks, especially as the cast majority of people with and eligible to claim Trivial Pensions will be basic rate or NIL rate tax[payers!

    See below from L&G triviality info sheet.

    Tax charge
    All trivial commutations of benefits in payment must be taxed in full as income of the recipient. However,where the member has not drawn any benefits from the scheme, 25% of the commuted fund may be paid tax-free. If the member has protected tax-free cash of more than 25%, then it would not be
    permissible to take the protected tax-free cash amount and commute the balance on the grounds of
    triviality. However, it would be possible to pay out any tax-free cash greater than 25% and then
    subsequently trivial commute the residual pension in the instant it comes into payment i.e. it never
    actually comes into payment, provided that the total benefits fall into the £18,000 limit.
    The pension or annuity payers of a trivial commutation lump sum payment must account for tax in
    respect of the payment under the PAYE procedures set out in booklet CWG2 (2011) (Employer Further
    Guide to PAYE and NICs) within paragraph 23. Once the payer has been handed form P45 parts 2 & 3
    from the former employment, the payer must use the emergency code, on a week 1 or month 1 basis, to deduct tax from the lump sum.

    However, HMRC has published draft legislation that looks to amend this process so that trivialities are taxed at the basic rate, with any under or over payment of tax being taken up between the individual and the HMRC.

    If however the payer or recipient believes that the recipient’s tax code from the previous employment or
    another code is more appropriate, they can approach HMRC before the payment is made and ask
    HMRC to issue such a code.

    As PAYE deductions frequently do not match the recipient’s actual tax liability for the tax year (in fact
    almost all recipients of a trivial commutation payment will have been significantly over taxed), HMRC
    has established an ‘in-year tax repayment’ claim procedure which allows those individuals who have
    overpaid tax to reclaim the excess amount immediately rather than wait until the end of the tax year.

    The scheme administrator has been advised by HMRC to include a note in their correspondence when the payment of the trivial lump sum is made.

  12. Just looked at older cases back in 2006 and HMRC were taking basic rate tax then rather than emergency tax. I wonder why they changed their stance on this when clearly it would result in more work to reclaim excess tax OR excess tax being paid and not refunded due to ignorance.

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