5 areas pensions policymakers need to address
18 December 2017
Andy Bell, chief executive of AJ Bell, outlines five areas of the pension system that he feels policymakers need to address in 2018:
1. Are pension death benefits too generous?
All the talk and speculation around how to reduce the costs of pensions to the Government focuses on pension tax relief. I think this is completely the wrong focus. Notwithstanding the complexities involved in implementation, the fact that people are not saving enough for their old age is one of the biggest social crises this country faces. Up-front incentives to save are therefore crucial. If the Government needs to keep a lid on the net cost of the UK pension system it could look at the revenue it loses through the generous tax rules surrounding pension death benefits that came with pension freedoms.
At the last count the gross cost of pension tax relief was £38.2 billion a year. But the Government also receives £13.4 billion in income tax on pension payments, making the net cost of the UK pension system £25 billion. Applying a reasonable tax charge to pension funds on death once they have served their purpose of providing an income in retirement, could reduce this net cost further. We could then move away from the constant speculation around the removal of up front incentives to save.
Pensions are meant to provide an income in retirement, not for wealthy families to use for estate planning. Any changes to the taxation of death benefits may go hand in hand with a simplification of the archaic way lump sum death benefits are distributed – currently at the discretion of the trustee or pension provider which creates uncertainty, delays and disagreement.
2. Over taxation of pension freedom withdrawals
This is clearly an area where the tax rules have not kept up with the changes to the pension rules. Following pension freedoms, the use of flexible withdrawals is by far the most common way people access their pension savings to fund their retirement. Many of these people use single ad hoc withdrawals yet bizarrely the tax rules say pension providers have to treat these as the start of regular withdrawals that will be made every month and tax them accordingly.
The result is that hundreds of thousands of UK pensioners are paying too much tax and not receiving the level of income they expect from their pension. This tax either has to be reclaimed via one of three forms or people have to wait for the wheels of HMRC to turn and hope that it processes the refund automatically.
This is clearly something that needs sorting out now that ad hoc pension withdrawals have become common place.
3. Growing inequality between DB & DC
Changes to the pension rules over the last decade have led to a widening gap between the benefits people can get from defined benefit (DB) and defined contribution (DC) pension schemes. With the continuing shift from DB to DC provision, this inequality is something that needs to be addressed. One particular issue is the Lifetime Allowance and how DB pensions are valued against it.
With a £1 million lifetime allowance someone in a DB scheme can take a lump sum of £250,000 and an inflation linked annual pension of £37,500, using the current 20:1 valuation multiple for DB benefits.
Someone with a £1 million DC fund can take the same lump sum but the remaining £750,000 would only buy an inflation linked, joint life annuity of around £18,750, half the level of the DB pension. This isn’t fair, particularly when you consider that most of society has already moved or will be moving into a DC pension environment.
Doubling the lifetime allowance to £2m, which incidentally is where it would be today if it had not been cut and instead increased with inflation, and changing the valuation multiple for DB pensions to 40:1 would bring us back to some kind of parity. There may need to be other changes to make this work, but it is something that needs looking at to address the growing inequality between DB and DC pensions.
4. The proposed reversal of pension freedoms
Whilst pension freedoms have broadly been a welcome development, one of the main unanswered questions remains whether people are making withdrawals that are sustainable.
One proposal to address this has been to call for guidance to be mandatory at the point at which people want to access their pension savings. This call has clearly been made by people who have never been involved in the process surrounding how people access their pensions in the real world.
Generall, people go through a two stage process, they decide how they are going to access their pension savings and then they take action. Guidance needs to be provided at the initial decision making stage, not at the point people are taking action and asking their pension provider for their money. They know what they want by then and putting a barrier in between them and their savings will be a reversal of the principles of pension freedoms.
5. Lack of progress on pension cold calling ban
It’s difficult to see why the ban on pension cold calling hasn’t happened yet. I can’t think of any occasion where a legitimate company would need to call someone out of the blue to talk about accessing their pension savings. The Government agrees with this and has committed to introducing a ban when parliamentary time permits. This is a clear fob off and until the Government finds the time, or more likely the desire, UK pension savers will continue to be targeted by scammers.
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