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Tom Selby: Pensions ideas factories fail the practicality test

Recent policy recommendations appear to have missed the fact it takes hard work and rigorous testing to turn a vision into something useful   

Wilbur and Orville Wright knew more about good ideas than most. The duo, more commonly referred to as ‘the Wright brothers’, were successful in building and flying the first airplane on 17 December 1903.

The Wright brothers did not just chuck bits of metal together that looked a bit like a bird and launch it off a cliff, however. They analysed the work of others, including German aviation pioneer Otto Lilienthal, and tested designs long before that historic take-off.

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This was not the end of the process either. The brothers recognised creating an aircraft that could fly for 58 seconds was not enough – they wanted to build a “practical flying machine”. By 1905, the Wright Flyer III was ready and the rest is history.

Anyone who has successfully built something will attest to the fact an idea, in and of itself, is not enough. It takes hard work and rigorous testing to turn a vision into something that is useful and works in a practical sense.

Sensible government and regulatory interventions should work in a similar way. Coming up with shiny new policies is all well and good, but only by consulting with those who are required to make these policies work – the oft-maligned ‘vested interests’ of the industry – can you really kick the tyres of the latest brainwave.

Unfortunately, practical thinking has been lacking in a number of recent policy recommendations.

Default pathways

The work and pensions committee recently published a report containing a series of reforms designed to improve the pension freedoms. Perhaps most controversial among these was a proposal to create ‘default pathways’ for savers who enter drawdown by April 2019.

The report does not spell out what it means by ‘default pathways’, which is not a great start. However, a helpful committee of researchers subsequently confirmed this would mean savers are automatically placed into a default investment fund when they enter drawdown.

This fund could be selected for them based on their responses to questions providers would ask, covering things like their age and withdrawal plans. The saver would have the option to opt-out of the default if they wanted to keep their existing investments.

A Royal Society of Arts report published soon after went further, suggesting everyone should be defaulted into drawdown at age 65 with a uniform withdrawal rate of 5 per cent a year.

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Both proposed ‘solutions’ make no attempt to explain how they would work in practice. The committee’s proposal, for example, takes no account of the fact many Sipp customers will have bought the product and chosen their investments with retirement in mind. In this scenario, why should entering drawdown automatically trigger a change in investment strategy? And what happens when someone accidentally fails to opt-out, is placed into a default fund they do not want and has to pay hundreds of pounds for the privilege?

Furthermore, I suspect many providers would be nervous about a process that requires them to ask customers a series of questions and then recommend a product based on their responses. That looks an awful lot like advice to me.

The RSA recommendation raises even more concerns. Some people would inevitably be pushed into a higher tax band and pay more than necessary to HM Revenue & Customs as a result.

There would also be people who, perhaps for inheritance tax reasons, want to leave their defined contribution pension untouched and simply do not want to make withdrawals. In addition, under the existing rules, a taxable pension freedoms withdrawal – whether automatic or not – would trigger the money purchase annual allowance.

None of these very basic issues are even mentioned in the report.

Pension tax relief

The headline proposal from the RSA report was, unsurprisingly, focused on pension tax relief. The RSA is not the first ‘think-tank’ to suggest scrapping higher-rate relief and replacing it with a 30 per cent ‘flat-rate’ for all.

Like many such ideas, it appears simple and appealing on the face of it – a kind-of retirement Robin Hood, where the rich get a bit less incentive and basic-rate taxpayers a bit more. However the devil is in the detail.

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We have been here before, of course. In 2015, then chancellor George Osborne published a consultation, ‘Strengthening the incentive to save’, which sought views on a number of radical pension tax relief reforms – including introducing a flat-rate. The proposals never got off the ground because of the mind-boggling complexity involved, most notably in relation to defined benefit schemes. How do you apply a flat-rate of tax relief to a scheme where the contribution is taken out of net pay? The RSA’s response? “Hurdles such as these are not insurmountable.”

Perhaps. But if you are going to propose a reform as radical as this, it would be useful to make at least an attempt to surmount it.

Tom Selby is senior analyst at AJ Bell


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  1. Robert Milligan 8th May 2018 at 2:43 pm

    Lets abolish the concept of HMRC funding any additional savings upon which those “Employed by Product Provider” can be remunerated by, we have PEP/ISA’s and now a LISA, please explain what other incentive do we need, these are Tax exempt savings providing potently growth and income, lets be honest, pensions are “Not Simplified”, not cheap for advice, and very old hat, the Death or near death of the DB schemes, and if they are not dead they should be!, has meant we compare the benefits of DC with the un-costed benefits of DB without understanding the true cost of a DB scheme. O yes, and I have sixty million under management in pensions and would ultimately lose out, but hey ho!

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