The Government is facing calls from the advice profession to rethink where it is heading with pension policy as the lifetime allowance and Lifetime Isa come under renewed attack.
At Money Marketing’s In Focus conference in London last week, the lifetime allowance and the Lifetime Isa were challenged by speakers and advisers for being unfair and potentially dangerous for consumers.
With the lifetime allowance sliding down and the Lifetime Isa’s introduction edging closer, is the Government at risk of damaging the pensions brand?
Pensions minister Richard Harrington was reproached by advisers at the In Focus event as they branded the lifetime allowance a “disgrace” that should be scrapped.
Yellowtail Financial Planning managing director Dennis Hall pointed out the difference between defined benefit and defined contribution schemes when it comes to the lifetime allowance and asked Harrington what the Government was going to do about it.
The lifetime allowance, brought in after pension simplification in 2006, fell from £1.25m to £1m in April. It was introduced at £1.5m and has previously been as high £1.8m. Current estimates suggest those in a DC scheme with a £1m pension pot would receive an income of around £30,000 while a £1m defined benefit pot would equate to £50,000 a year.
The allowance has been described as “out of kilter”, “inequitable” and a measure “that should never have existed”.
Altus Consulting senior consultant Jon Dean says: “If you were just reforming the rules, then you would need to equalise the allowance so DB and DC were treated broadly the same, but I am with the majority that the lifetime allowance isn’t the perfect solution. Part of the difficulty is it punishes good performance and diligent savings. The fact is it is not a limit on the amount you save but on the amount in the pot and you do not know how the pot will perform until close to retirement age.”
While the industry has been vocal in its calls to scrap the lifetime allowance – on both the adviser and provider side – many believe it is unlikely to be abolished while it remains a steady tax revenue stream for the Government.
HM Revenue & Customs data rev-ealed through a Freedom of Information Act request by AJ Bell this year showed the Government had collected £353m in tax from the lifetime allowance between 2006/07 and 2014/15.
Aviva financial research head John Lawson says: “After the Autumn Statement, the Treasury made it clear they are not looking at tax relief or tax incentives for pensions at all at the moment.”
While the advice profession might not see change in the short term, firms believe issues with the lifetime allowance reflect wider problems with pension tax relief and have laid out the changes they want to see.
Hymans Robertson partner Chris Noon says: “What we have now is a mess. The lifetime allowance is too low, DB and DC is wrong, the annual allowance is a complete and utter mess. Pension tax relief needs to be looked at because at the moment it is completely unsustainable. That is something the Government should be doing, my worry is with Brexit it will not be looked at particularly quickly.”
AJ Bell platform technical head Mike Morrison says it remains unclear where the Government is headed with pensions policy and whether former chancellor George Osborne’s tax relief plans would continue or whether Chancellor Philip Hammond might devise his own blueprint. He says: “We are still not sure if we are in the old plan, which meant heading towards pension Isas, or a new plan. What we could do with clarification that pensions will co-exist together and we are not going to replace pension tax relief with Isas. I don’t mind having Isas alongside a pension but the emphasis should be on long-term saving for your retirement and not necessarily to buy a house.”
Lawson argues incentives should be skewed towards people who are less wealthy. The Government has already said it does not like the fact that pension tax relief is mostly spent on those portions of society that earn the most.
Lifetime Isa fears
Another Government savings initiative that has been criticised for its potential to dilute the pensions brand is the Lifetime Isa, which is expected to launch in April.
Speaking at the In Focus event, former pensions minister Baroness Ros Altmann warned of the potential for misselling with the Lifetime Isa.
She said: “It is difficult for me to see the rationale in making this a quasi-pension and muddying the pensions landscape unless you want to somehow dumb down pensions.”
The FCA released its consultation paper on the rules around promoting and distributing the Lifetime Isa in November.
It said investors in the Lifetime Isa should be given specific risk warnings around incurring the early withdrawal charge, which would lead to investors receiving less from their Lifetime Isa than they paid in. Withdrawals can be made to buy a first home, from age 60, or if a saver becomes terminally ill, but funds taken out for any other purpose incur a 25 per cent penalty charge on the whole fund, including any growth.
This charge will be waived in 2017/18, but the Government says savers will not have to take advice.
The FCA also wants to see risk warnings to investors about the possibility of losing an employer contribution to an eligible workplace pension where an investor chooses to open a Lifetime Isa instead.
Also speaking at the event, Pensions Policy Institute director Chris Curry said: “There are not many other products I can think of where you will lose so much taking money out at the wrong time. It will not be immediately obvious to people as this is part of the Isa suite of products – I don’t think there are exit charges on any of the others.”
Curry called the Isa charging structure “opaque” and recalled a past disagreement with a work and pensions select committee chair who insisted there were no charges on Isas. He said: “We know there are charges on Isas it is just that nob-ody knows what they are and you cannot see them and they are not advertised.”
Nucleus product technical manager Rachel Vahey says withdrawals from the Lifetime Isa to pay for advice should be exempted from an exit charge. Charges for running costs can be taken from the product without a penalty, for example, through platform fees. She says: “We think people should be allowed to pay an adviser charge from their Lifetime Isa and it should not incur a charge, whereas at the moment if you took money out to pay an adviser that would incur a 25 per cent charge. It means you are taking back the bonus the Government has given you and any growth on that bonus.”
Pensions and Lifetime Savings Association external affairs director Graham Vidler is concerned the “Isa brand” could be tarnished by the Lifetime Isa product and expects it will not be marketed hard, which will keep consumer take-up low.
He said: “We talk about damage to the brand of pensions and long-term savings but Isas have always been very pure and very popular. There is a real risk to the brand of Isas both from the sheer complication of having a sixth or seventh type of Isa but also from the risk of – even if it is only a small amount of people buying it – it is still not right.”
Others in the industry are more optimistic about the Lifetime Isa. Lawson considers there would have to be two changes to the product before it damaged pensions.
He says: “Either the incentives for Lifetime Isa versus pension are strengthened or you allow auto-enrolment into the Lifetime Isa instead. If either of those things happened there is huge potential for collateral damage. At the moment people have to consider the ins and outs of a Lifetime Isa before they do it. Equally, those promoting the Lifetime Isa have to be careful about the clients they are taking on.”
Prudential technical head Les Cameron
One of the problems with the lifetime allowance is that economic circumstances and a reduced limit means more people are paying more tax.
The lifetime allowance is a cap on the overall amount of tax-privileged benefits you can save in all your pension schemes before you pay a tax charge. It is tested when you take your benefits, or reach age 75 if later, as opposed to during the savings phase.
Like any other allowance in the tax system, it is designed to collect tax when the value breaches a certain limit. The problem is the valuation basis of defined benefit pensions and level of allowance are inconsistent with today’s realities.
Let’s go back to the beginning of the lifetime allowance. Back in 2006 it was set at £1.5m, a level that roughly coincided with how much it would cost to buy an income based on two-thirds of the then earnings cap of just over £105,000. With some spouse’s benefit and inflation proofing, this was about 20 times the pension and settled on £1.5m.
This level was to then increase in five-year intervals and reached £1.8m before it started to fall to its current £1m.
For lifetime allowance purposes, defined benefit schemes are valued at 20 times the pension paid plus any pension commencement lump sum paid. For money purchase schemes the amount tested is basically the fund value you are taking, which will be part pension commencement lump sum and part drawdown fund/annuity purchase price.
Although lifetime allowance valuation rules have not changed, the economy – particularly long-term interest rates – have.
A recent example illustrates the issue. Under current economic conditions £1 of DB income is roughly multiplied by 30 when calculating a transfer value but can be much higher. I recently saw a transfer value of 48 times the annual pension. A £10,000 income had a transfer value of £480,000.
For lifetime allowance purposes, taking benefits in the scheme uses £200,000 of the lifetime allowance but transferring out before taking benefits uses £480,000. Although 48 times pension is an outlier in values, 30 times pension on transfer values is fairly normal. Perhaps this disconnect in values needs addressing?
The second issue causing tax problems is more straightforward. In 2006, a £75,000 income would use up £1.5m of lifetime allowance, which would have been broadly in line with the cost of the benefit. Today, based on the 30-times figure, this should be £2.25m – well in excess of £1m. This means that for defined benefit schemes you can now only get £50,000 a year within the lifetime allowance.
There are many perceived problems with the lifetime allowance but perhaps fundamentally we need to consider how pension benefits are valued?
There used to be an overall limit on the level of occupational benefits that could be built up and a limit on contributions. Personal arrangements got tax relief controlled by the contributions payable with unlimited benefits on exit.
Is it perhaps time to have different lifetime allowance treatment for DB and DC plans?