June CPD Newsbrief — Pensions and retirement planning
Are the new KFI rules OK?
Concerns have been raised over the new rules for real-terms key fact illustrations (KFIs) for pensions introduced by the FCA in April 2014.
A combination of a lower rate assumption of 2% nominal annual growth and an additional assumption of 2.5% annual inflation means that projections are now showing outputs (in real terms) that are less than inputs (in nominal terms). The regulator’s research has identified that consumers find pension illustrations poorly designed, too long and overly technical.
Under the new rules, KFIs should be altered to show information in real, rather than nominal, terms, and achieve greater consistency with statutory money purchase illustrations (SMPIs). This should help consumers to appreciate the effects of inflation and plan more effectively for their retirement. The assumed rates of investment return have also been adjusted from 5%, 7% and 9% to 2%, 5% and 8%, with the inflation assumption fixed at 2.5%.
Projecting a fund value using a 2% growth assumption produces a substantial negative return in real terms if inflation is fixed at 2.5% after taking into account fund, platform and adviser charges. Even at 5% annual nominal growth, the projected net real growth rates can be close to zero. Furthermore, as ISAs will use similar projection rates without an inflation assumption, there are also concerns that consumers may see ISAs as offering better overall returns, and so favour them over pensions. However, the rules also require that a statement be included in the KFIs of other savings and investment products to confirm that the effects of price inflation apply equally in those cases.
Advisers will need to make their clients aware of these changes and explain why the figures may have reduced from their last statement. They may also need to review fund and platform charges as well as their own adviser charges.
Pensions tax relief under attack
The Institute for Fiscal Studies (IFS) has described the tax regime for employer pension contributions as “extraordinarily generous” and called on the government to make them subject to employer NICs.
It also urged the government to restrict the ability to withdraw a tax-free lump sum from larger pension pots, arguing against any further restrictions on income tax relief on pension contributions. Meanwhile, the right-wing Centre for Policy Studies (CPS), in its latest publication “Costly and Ineffective: Why Pensions Tax Relief Should be Reformed”, calls on the government to scrap tax relief on pension contributions entirely. It believes that the relief primarily benefits higher-rate taxpayers and does little to motivate low earners to save for retirement.
The CPS also wants NIC relief on employer contributions continued as a means of encouraging employer engagement with pensions. It goes further than the IFS in arguing that the 25% tax-free lump sum should not just be restricted, but be replaced with a 5% top-up of the pension pot pre-annuitisation.
The report proposes various compensations for the removal of tax relief. They include a matched savings scheme, under which for every £1 that a member or employer adds to a pension pot, the state puts in a fixed additional amount. Another is a ‘no-lose lottery’ that would guarantee a 50p return on a £1 pension contribution, or even a persistency bonus that would grow over time. A further suggestion was a single flat rate tax relief of 25% or 30% to incentivise low earners to save.
Class 3A opens for business
From October 2015, people who reach their state pension age before April 2016 will be able to pay into the new Class 3A Voluntary NIC — called ‘state pension top-up’ — to boost their additional state pension. The contributor can buy a maximum of £25 a week extra pension.
The intention is to give people in the pre-single-tier population the opportunity to increase their state pension in retirement.
The state pension top-up that people can buy far exceeds the private pension currently available on the open market. Spending £22,250 would buy a pension of just more than £700 a year for a 65-year-old with a 50% spouse’s pension, escalating in line with RPI, but with no guaranteed period (Money Advice Service, 6 May 2014), compared with £1,300 a year (£25 a week) state pension top-up. Some people could get better value from an enhanced annuity if they have health or lifestyle conditions.
The Department for Work and Pensions (DWP) has been asking people close to state pension age for their views on this opportunity. One in five were either very or fairly interested in taking up the offer, and the DWP estimates that 265,000 people may apply. The DWP anticipates that the offer will be of most interest to women and the self-employed.
There is only a short window of opportunity — 18 months — for those interested in buying state pension top-ups. And people will have a three-month cooling-off period if they change their minds.
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