There has been something close to a revolution in the pensions’ market in recent years. People now have unprecedented flexibility to save for and manage their retirement finances as they choose. Yet just as people are digesting their new-found freedoms, the Chancellor has suggested that he is willing to consider even more radical change.
The details are sketchy. The Chancellor said in yesterday’s budget that he would launch a Green Paper to consult on whether the pensions regime should be more like the ISA regime. He said: “Pensions could be taxed like ISAs—you pay in from taxed income—and it’s tax free when you take it out. In between it receives a top-up from the Government”. He added that the Paper would “ask questions, invite views, and take care not to pre-judge the answer.”
Pension insiders have long complained that the constant flux in the system makes it difficult to plan. The pensions system is complex, which may deter people from saving. ISAs retain a ‘halo’ effect because they have been relatively immune from government tinkering. Maike Currie, associate investment director at Fidelity Personal Investing, says: “What the current regime could really do with is some stability and relief from further meddling.”
Nevertheless many agree that bringing pensions into line with ISAs may build trust. Shaun Port, chief investment officer at Nutmeg, says: “ISAs are still trusted by the population because they haven’t been damaged by the government. New flexibility and making pensions more like ISAs will improve engagement and encourage people, especially younger people, to save early and often. But the Chancellor should still encourage savings through the tax system.”
He adds that the Government should still proceed with caution to ensure pensions remain a viable vehicle. This means some changes to those rules that appear anachronistic would help. Port says: “We think that the lifetime allowance should be applied to contributions rather than the whole pension pot—this would level the playing field and would mean that investors are not punished for good behavior—namely starting early, taking the appropriate amount of risk, and not flinching when the markets dip.”
Fidelity’s Currie agrees that pensions could benefit from becoming more like ISAs: “The only way to encourage more people to save is to keep the rules as simple as possible. ISAs are a truly trusted product within the financial services industry—they’re simple, easy to understand and accessible.
“It remains to be seen if the benefits of saving for retirement from taxed income will far outweigh upfront tax relief. It would be disastrous if people were to save for retirement only to find in later life that a cash-strapped government changes the rules again to tax income for a second time. No saver will want to take this gamble—today’s system is not perfect, but it does give everyone an incentive to save.”
The other key initiative in the budget was to taper tax relief on pensions for high earners from April 2016. For every £2 of adjusted income over £150,000, an individual’s Annual Allowance—the limit on the amount of tax relief available to an individual or their employer each year—will be reduced by £1, down to a minimum of £10,000.
Investors may still be able to contribute up to £80,000 in the current tax year and receive tax relief at the full rate. Hargreaves Lansdown points out that from 9 July, most people will have a £40,000 annual allowance for the rest of the tax year, even if they have already made pension contributions this year.
This reduction in tax relief had been well-flagged, but was not accompanied, as many had expected, by a revision of the salary sacrifice regime. Therefore, those just edging into higher rate may still be able to use the salary sacrifice regime to bring their earnings under the threshold.
Malcolm McLean, senior consultant at Barnett Waddingham, says the proposal will create some administrative difficulties in its implementation, particularly in relation to defined benefit pensions. He also pointed out that the Government had not provided any clarity on the resale of annuities, with any decisions deferred until the Autumn.
The Chancellor may have ambitions to make the pensions’ regime simpler, but in the meantime this Budget has only brought greater complexity. Following the reduction in the lifetime allowance and other changes announced in the last Budget, retirees need to be even more vigilant about their pension arrangements.
