The Government has re-framed pensions as long-term savings plans, rather than as a package that pensioners swap for their salaries, says Aries' Ian Neale.
By common consent, this year's Budget was a game-changer for pensions in the UK. Unusually, the reaction has been largely supportive. This week we found out how the Government plans to make it work. There are questions still to be answered, notably how the guidance guarantee is going to be funded, but we are now clearer about key policy changes: such as freeing annuities of the straitjacket. It won't be easy for providers to make annuities attractive; but the possibility for example that the value could move with interest rates, even in either direction, might appeal to cautious retirees at a time when rates are stubbornly stuck at a historic low.
Arguably the most significant change is opening flexible drawdown (FD) to all defined contribution (DC) scheme members, with a permissive statutory override to enable trust-based schemes to offer this without going to the expense of changing their rules. Members of the many schemes that won't wish to allow drawdown will be able to transfer to a drawdown provider, right up to the date they choose to retire. So far so good, but in an era when most DC pensions are being funded via salary sacrifice, the opportunity here for tax avoidance was a big challenge for the Government.
If you are 55 and able to negotiate your salary, it might make sense to divert enough of it to use up your annual allowance to a pension arrangement, if you could then immediately take 25% tax-free. The rest, after tax, could be reinvested in a new arrangement and grossed up. If you could do that every year, the prospect becomes practically irresistible.
The hardline solution to this tax avoidance would be to apply the current rule for FD, which prevents any subsequent pension contribution benefiting from tax relief. But they haven't chosen that rule. Nor has the Government opted for what was rumoured, namely no tax-free cash for ten years on the proceeds of any post-FD contributions. That might have been as impractical to police as the risible recycling legislation in the 2006 Finance Act.
Instead, to their credit, the Government has taken a proportionate view, and will allow a modest cash withdrawal of up to £10,000, over and above the tax-free cash allowance, without any effect on the £40k annual allowance. Personal pension holders will be able to do this three times. Only 2% of individuals, the Government estimates, might want and be able to take more than £10k via FD - and even these people are to be encouraged to continue saving, with a £10k annual allowance (also given to those already in FD).
It amounts to acceptance, at long last, that is not sensible to pretend that a complex web of rules can succeed in eliminating tax avoidance. Deploying a battery of sledgehammers to deal with a few nuts is counterproductive. The cost of compliance and lack of incentives simply turns people off saving altogether.
There are risks inherent in the new strategy, as I said here in April; notably in relation to future societal and intergenerational cohesion. However, disillusionment with pensions had reached the point where to many the very word appeared toxic. Something had to be done: the tax-free lump sum was no longer a sufficient incentive.
More than anything else, what the Government has done is to re-frame pension arrangements as long-term savings plans; no longer simply a package you swap for your salary (with very little choice) when you finish work. Now you have some control over your money.
With this comes a challenge to the DC pensions industry. Can it re-frame its approach to the public: will it adopt solution selling in place of product pushing?
Written by Ian Neale, director, Aries Pension & Insurance Systems Ltd
ian@ariespensions.co.uk
