The Pensions Green Paper might have been disappointing but the same cannot be said of the proposals for tax simplification, launched in a simultaneous consultation paper.
Consider the joint objectives:
Providing choice for everyone by simplifying the structure and removing the mystique born of years of legislative “tinkering”.
Increase protection for members of occupational schemes, especially where schemes close or wind up.
Promote pensions, through greater employer communication and workplace advice.
Encourage flexible retirement patterns, enabling individuals to control the timing of their own retirement.
The Government considers the financial services industry a key partner in the development of pensions but it recognises the need to rebuild investor confidence if the savings and pensions gaps are to be closed by any appreciable degree.
Closing the gap
The Government's view is that investors who should be saving for retirement have been discouraged because the whole issue is complicated. Furthermore, investors mistrust pensions due to issues such as Maxwell, the Equitable Life situation and pension misselling.
There may be an air of naivete in the view that the continuance of current tax relief', buoyed by a greatly simplified structure and low product charges will encourage the general public back to the pension market.
But it remains to be seen if this has any significant effect upon investment habits or just alter tax planning opportunities for the wealthy.
Pension planning requires a high degree of commitment from investors and it is arguable whether the proposals will succeed in raising this issue higher in the league of investment priorities.
For some, the Government has sidestepped the issue by avoiding the introduction of compulsory contributions. This remains a major point in the discussions and a nettle that may yet need to be grasped.
Most commentators agree that the Pensions Green Paper comes up short in certain areas but the Government's attitude to tax simplification has generally been loudly applauded.
Rarely have we seen a Government prepared to tackle an issue with one bold sweep of the legislative sword and it deserves a degree of credit.
If the proposals are implemented, then all the previous complexities would be replaced by one simple regime.
Personal contributions in a year will rank for tax relief up to 100 per cent of chargeable earnings or £3,600 if higher. No complicated matters, such as basis years, cessation years, carry forward, carryback.
Annual limit of £200,000 per tax year, within which there is no upper limit on employer's contributions.
Indexed lifetime limit on the fund, inclusive of investment growth, of £1.4m, tested only as benefits are taken.
The option to take 25 per cent of the fund falling within the lifetime limit as a tax-free cash sum.
The balance of the fund falling within the lifetime limit to be used to provide retirement income.
The limit of £1.4m has been broadly based on the fund size required for a male aged 60 providing pension benefits roughly equivalent to the current Inland Revenue maximum, that is the level of the earnings cap, index linked with spouse's pension. Women reading this article may need no encouragement from me to voice their own opinions of this calculation.
Even the best intentions result in complexity when it comes to the practical application of the scheme.
Chargeable earnings are not defined in the paper but it is assumed that current definitions will apply. It remains to be seen if there will be tax incentives, other than the basic level of £3,600, for individuals to top up pensions after earnings have ceased.
The annual limit, (“value inflow”), will be simple to understand for money purchase plans because it will relate to the total contribution level. However, for final salary benefits, the limit will apply to the monetary equivalent of any increase in the value of their benefits.
Any fund value at retirement in excess of the lifetime limit will be subject to 33 per cent “recovery tax”, to reclaim the relief enjoyed dur-ing its lifetime.
From the net residue, 25 per cent can be taken in cash with the balance used for retirement income. However, all benefits emerging from the excess will be subject to the individual's marginal rate of tax. That portion of the fund would have paid withholding tax, tax at 33 per cent on the whole amount to recover tax relief's and income tax when it is drawn.
It is proposed that the annual limit will be tested through self-assessment with the introduction of a new worksheet and the onus will be on the individual.
The assumption in the consultative document is that few people will be affected by either the lifetime or annual limits and, considering how few people currently retire on Inland Revenue maximum benefits, it is hard to disagree.
The potential changes to investment rules are of particular importance to clients using small self-administered schemes and self-invested personal pensions.
The consultative document states clearly that the Government is in favour of a single regime to maintain simplicity.
SSASs have been highlighted as affording limited protection for members' pensions, using tax breaks for reasons other than providing retirement income.
There will be transitional rules applying to schemes in force on the date that the new regulations become effective. However, since the new rules will apply to all pensions in future, investment options are likely to become more restrictive.
More words will be written between now and A-Day. What we have seen is just an opening salvo. Clearly, the Government is willing to make retirement saving easier and has the boldness to rewrite the rulebooks. Whether its proposals will provide sufficient encouragement to close the gap remains to be seen.