Do you think the Inland Revenue's delay in publishing its report into taxation of pensions is because it is adjusting its proposals to make them more complex or less complex?
Clarke: I doubt very much that the Inland Revenue will make recommendations to the pension tax regime that would complicate the existing minefield of rules and regulations, particularly as the DWP is determined to simplify pensions. It is vital that the Green Paper demonstrates that there has been joined-up Government thinking in tackling the pension crisis and that any recommendations made take a holistic view of pensions.
Stanbridge: We suspect that the delay is an effort to produce a more radical set of simplifications to the Inland Revenue rules. The general feeling was that the Pickering proposals were biased towards occupational final-salary pensions and will not deliver enough simplifications in the money-purchase pensions arena.
Folkard: I would hope that the delay means that simplification is proving difficult but not impossible and that a radical solution is being developed. Successive legislative changes since 1987 have merely added layers to an already complex area. This time, the demand for simplicity and transparency deserves a comprehensive rethink. In addition, much of the current cost of advice results from having to deal with previous revenue regimes. Simplification would enable the advisory process to be simplified and make access to affordable advice easier to obtain.
Would abolishing the tax-free cash at retirement option make fewer people take out pensions?
Clarke: Not necessarily. The greatest incentive for savers is tax relief on contributions. The ability to take tax-free cash from a pension fund is arguably def-eating the core objective of providing adequate income levels in retirement and, to a degree, defeats the objective that pension saving is designed to provide an income in retirement.
Allowing 25 per cent or greater from the retirement fund without liability to income tax provides a greater benefit for wealthy or higher-rate taxpayers who have potentially already enjoyed higher-rate tax relief on pension contributions. Alternative savings vehicles, such as Isas, offer tax-efficient savings opportunities for those consumers who want to acquire a lump sum at retirement to meet financial aspirations.
By abolishing the tax-free cash option, the additional income tax revenue available from annuity income could be used to raise the personal age allowances, further enhancing the net income available to those pensioners who need it most. This could be financed on a basis of “no additional expenditure to the Treasury”. Indeed, by increasing the regular income of pensioners, it should mean that fewer people would be dependent on state means-tested benefits.
Stanbridge: Yes, tax-free cash is one of the genuine tax breaks from a pension scheme, as many would argue that the pension is taxed as earned income and, therefore, the tax relief on contributions is simply a deferral from paying tax.
Tax-free cash is widely used to create a capital sum that can repay lifetime borrowings such as mortgages and its removal would break an important Government promise. The removal of this or taxing it would be a negative move at a time when the Government is concerned about encouraging more people to save through private pension schemes.
Folkard: It depends what the alternatives are. There is evidence that consumers value flexibility as much as incentives and any reform of taxfree cash might be palatable if combined with more flexibility, for example, the option to draw benefits while still in employment.
This would enable a phasing of retirement, allow people to continue in work on fewer hours if they choose and address some of the skills shortage issues that employers will face as the working population decreases in relation to the number of pensioners. Reform of tax-free cash rules should be balanced, with more incentives to contribute, especially for younger ages where the resistance to pension funding is higher but the greatest longterm impact can be achieved.
Do you expect annuity products to move more risk from life companies to individuals in the future?
Clarke: Annuities, which provide income for life, are one of the most important elements of retirement planning and must provide an income for life. However, with low investment returns coupled with increasing life expectancy, there is little reason to believe that there will be an increase in the level of annuity rates that are payable across the UK pension industry.
This has prompted a rethink of the traditional methods of annuity provision, with the emphasis being put on flexibility, transparency and value for money for all. However, with some of these innovations, there is also scope for transference of risk from the insurer to the individual. We believe that the traditional method of providing an annuity, which pools mortality risks, is the most suitable vehicle for the majority of annuitants who cannot afford to take a risk with their savings.
Stanbridge: In general, the risk inherent in annuity rates is based on the principle of pooling risks of a population of annuitants. In this market, there are winners and losers in terms of how long an individual draws the annuity. The downside of annuitants dying shortly after retirement can be minimised to some extent by building in guarantee payment periods and contingent annuities that are paid to a spouse or dependant.
However, the price for this is a lower starting annuity for a given purchase sum. Pensioners have seen annuity rates fall dramatically and they do not like it. The principal drivers in determining the annuity offered are the allowance made by the actuary for future mortality experience and the investment returns that can be achieved on the capital purchase sum. Because pensioner mortality is constantly improving, it will be paid for a longer period. Quite reasonably, this means a lower starting level of annuity.
Further, long-term interest rates are at a 30-year low, so the actuary cannot expect to earn as much interest on secure Government stocks and bonds so this also has the effect of lowering the amount of the starting annuity. Pensioners in the main like and need the security that their pension payments will not fall. Some may be able to speculate and invest in funds that may fall in value and they accept that their annuity could fluctuate. Providers are just responding to the market by offering the with-profits-style of annuity or income drawdown products but the conventional guarantee annuity will remain very popular. The real solution is to save more or defer taking a pension.
Folkard: The current annuity regime is inflexible and long overdue for a rethink. Individuals should not be required to anticipate future requirements and fix their benefit structure at a prescribed date. There should be a choice to phase purchase or draw income from an actively invested portfolio while retaining the option to purchase conventional guarantees when appropriate. Such flexibility will involve the risk-associated active investment complemented by the ability to lock into the guarantees associated with annuities. The individual then has a choice about benefits and a level of risk that they find acceptable.
Would Pickering's call for less prescription in pension legislation leave IFAs open to a greater risk of misselling?
Clarke: We do not believe that less prescription necessarily leads to misselling. With the number of pension products available, each of which is governed by a complex amount of legislation and/or regulation, the opportunities for mis-selling now are greater than they would be under a simplified framework.
The introduction of a two-tier advice regime in which there is a less prescribed, more off-the-peg approach to lowervalue sales may well be the way forward. Experience shows that consumers prefer this approach and we feel that they can be given what they want without any resultant drop in the level of service provided. In this simplified advice regime, IFAs would have less regulation to comply with, fewer products to recommend and, we feel, be less open to charges of misselling.
Stanbridge: Less prescription invariably opens up the market to more choice. More choice means that a different decision taken years ago may have delivered a better result. As we all know, hindsight is a wonderful gift that few of us possess. Unfortunately, we are increasingly becoming a society that looks for a scapegoat where our past decisions do not produce the best possible outcome in the future. Regrettably, it will mean that some will use the IFA as their whipping boy and the risk of being accused of misselling is a risk that IFAs face.
Folkard: Provided that the regulatory framework operates in a preventive fashion, creating an environment for effective advice without becoming overly costly, it is likely that a simplified pension regime could be successful. Simplification of product does not necessarily mean less requirement for regulated sales.
However, it may allow for a two-tier system which could open up cost-effective advice to a wider audience. Much has been said on this subject and it would be naive to assume that regulation of the product environment is an effective substitute for experienced and well qualified advisers.
Will union strike action halt the drift from defined-payment to defined-contribution pension schemes?
Clarke: I do not think that union action itself will halt the drift from DB to DC schemes. In an age of poor investment returns, over-regulation and bewildering accounting standards being imposed on employers, it is in many ways inevitable that employers will seek to limit their future liabilities.
However, the threat of union action is raising public awareness as to the size of the pension crisis that is currently facing the UK and so is making a genuine contribution to finding a solution. A well funded DC scheme is a valuable employee benefit. It is only when employers are allowed to cut their contributions that the overall value of the benefit is reduced. According to latest figures, the average employer contribution rate for DB schemes is 12.46 per cent while for DC schemes it is 7.19 per cent. Emphasis by the unions on this aspect may be more fruitful.
Stanbridge: No, it seems inconceivable that union pressure will stop employers determining their future remuneration structure and the pension scheme is one element of the employment package. Finalsalary schemes have become increasingly expensive and unacceptably unpredictable for employers in budgeting for future costs.
One of the key drivers of the finances of final-salary schemes is the cost of annuities. These are set to remain increasingly expensive. Add to this the poor returns for the past three years from the stock-market and the increasingly complex regulation and one can understand why many employers do not want to sign up voluntarily for final-salary schemes in the future.
The unions are more likely to have success in ensuring that employers continue to contribute decent levels of contributions into company and occupational money-purchase schemes plus continuing to provide good levels of pre-retirement death benefits and income in the event of long-term sickness.
Folkard: Probably not. But it brings a number of important issues regarding pension benefit expectations thundering into the public domain. The drift from final-salary schemes is only one aspect of a much wider debate which includes not only the expectations we have of employer-based schemes but also the state and, indeed, the individual.
The reasons that pensions are now a significant social issue are regrettable but hopefully the public will become better informed and so they will be well placed to make informed decisions about what is best for their own futures.
Do you expect the number of people being short-changed on the closure of final-salary schemes to increase?
Clarke: At present, I see no reason to expect a reduction in the trend of final-salary scheme closures. Since the early 1990s, smaller employers have been looking for other ways to provide pensions for their employees and recent developments have caused many of the bigger employers to join them. Recent surveys on those remaining DB schemes provide little comfort.
A survey of 2,950 DB schemes by the Association of Consulting Actuaries found that only 37 per cent were currently open to new members and, of these, 47 per cent are contemplating closure. DB schemes are seen by increasing number of employers as more expensive to fund and to administer due to the complex legislation and regulations that govern them. Should the Government choose to simplify the pension framework, this may encourage some to continue with their DB schemes. If employers involve their employees in the process and find the most suitable form of occupational pension provision, it will be less painful for all concerned.
Stanbridge: This is a real possibility, as some employers will take the opportunity to cut back on pension scheme expenditure by reducing contribution rates to money-purchase schemes.
Folkard: This probably depends on the outcome of Pickering and Revenue reviews. If protection for longer-serving or older members is adopted, then the needs of those closest to retirement will be protected. This would then raise a whole host of issues about fair treatment for scheme members as a whole.
The money to resolve this issue must come from somewhere and, in a buoyant investment environment, we would expect equity investment to provide a lift and address the deficits which many schemes are faced with. This may still prove to be the case in the longer term but I suspect the closures are being driven by employer concerns about cost control, which has long been an issue with final-salary schemes.
Martin Clarke, General manager, CIS
Paul Stanbridge, Head of corporate pensions marketing,Friends Provident
Steve Folkard, Head of pensions marketing, Axa