Having just spent a week out and about talking to advisers, I was reminded just how unnecessarily complex our pension system is. There are some obvious changes that could be made, which would make a real difference.
1: Separate defined benefit and defined contribution rules
Trying to apply one set of rules to DB and DC schemes has long created unnecessary complications. If we got this right, a number of those could be eradicated.
If we were to separate the rules we could also then accept the cost of pension tax relief for each of them needs to be controlled separately. The cost of DB schemes should be controlled through a lifetime allowance at the point at which people take benefits, while the cost of DC schemes should be controlled at the point people make contributions via an annual allowance.
The lifetime allowance can then be scrapped for DC pensions and the seven various forms of protection that exist around historical levels of it would mercifully fall away.
2: Review the DB to DC pension transfer process
The transfer value analysis rules were introduced in 1994. It is fair to say a lot has moved on since then. However, the rules remain the same today despite the fact the market has changed significantly. For example, pension freedoms and fears over the ability of DB sponsors to pay pensions have fundamentally changed the DB to DC transfer equation.
FCA rules still stipulate that an assessment of DB to DC transfers must start with the assumption it will not be in the client’s best interests. This feels outdated in the post-pension freedoms market and at a time when many DB schemes are in deficit.
In the majority of cases the result is still likely to favour the guaranteed benefits of a DB scheme, but there will be circumstances where more flexibility can deliver a better outcome.
With more and more people having a combination of DB and DC pensions, now is the time for a fundamental review of what constitutes good practice around transfers from one to the other.
3. Leave pension tax relief alone
If there is one thing commentators would agree on it is that people are not saving enough for later life. There is no doubt complexity is a barrier but so is constant change. People are suspicious of pensions and can be reluctant to put their money into a product where someone can (and often will) change the rules at any point.
I understand the cost of pension tax relief needs to be controlled by the Government but once the DB and DC systems are separated this can be done by the lifetime allowance for DB schemes and the annual allowance for DC. I would favour reducing those allowances to control the cost of pensions rather than messing around with pension tax relief.
Reducing the annual allowance for DC pensions to a level that is affordable and sustainable would also mean we could wave goodbye to the hideously complex annual allowance taper for high earners. If that remains, a lot of people are going to get an unexpected and unwelcome tax bill next year.
4: Introduce an independent Pension Tax Commission
Finally, to stop all the good work of reform being undone by short-term political whims, create an independent commission tasked with overseeing the long-term policy around pension taxation and incentives.
The Pensions Tax Commission would be tasked with setting the allowances for pension tax relief, so that they are consistent across DB and DC, affordable to the Government and sustainable over the long term.
The commission’s recommendations could form the basis for a lasting, cross-party settlement on pensions tax relief and should come with a pledge not to make any further changes for at least 10 years.
This would end the continuous speculation around changes to tax relief, meaning people can make decisions without fear of constant upheaval.
Mike Morrison is head of platform technical at AJ Bell