Category — Auto-Enrolment, Private Pensions and NEST
4 September 2016
|1||You get free money from employer – often a matching contribution to double your money||No employer help with your property purchase|
|2||You get extra from tax relief – on top of an employer contribution can more than double your money||No tax relief on money you use to buy property|
|3||No income tax to pay on income earned in a pension fund||All rental income taxed|
|4||No capital gains tax to pay on assets that rise in value in pension fund||All capital gains taxed on second property|
|5||No inheritance tax when passing on pension assets||Property assets subject to inheritance tax|
|6||Inherited pension assets stay tax free until money is taken out||Inherited property income will be taxed|
|7||Costs of buying pension are controlled||Costs of buying property can be significant|
|8||Costs of managing pension usually around 1-2% a year||Costs of managing property can be significant – agents’ fee, repairs, empty periods etc.|
|9||Pensions can invest in property funds and commercial property to spread risk||Buying one or two properties has more risk than buying many properties|
|10||Pensions can also invest in other assets to spread risk||Relying only on property is putting all your eggs in one basket|
So what is better when saving for your retirement – property or a pension?
Pensions have many advantages: Pensions allow you to spread the risk and also offer you many other benefits as well. It seems a real shame that so many people, apparently even those who have the most valuable type of pensions of all, fail to understand how much they are worth. I would like to explain just how valuable pensions are and why they would normally be the best way to save for retirement – even better than property.
You can more than double your money with a pension: The first thing to say is that, if you are in a workplace pension and you opt out of it to rely on property, you will lose free money from your employer. Many employers will match your own pension contributions. So, if you earn £25,000 a year and you put 8% of your salary into a pension, that amounts to £2,000 each year. £400 of this, however, will come from basic rate tax relief, so your own actual investment in your pension will be £1,600. And, if your employer offers a matching 8%, then you have another £2,000 going into your pension fund too.
You put in £1600 and it can become £4000 straight away: In other words, £1600 of your money has gone into the pension fund and you have received an extra £400 from taxpayers and another £2000 from your employer. So, on day one, your £1600 is worth £4000. That is more than double your money.
Even if property prices double and pension investments make no return, you could do better in pensions: If you pay £1600 a year into a pension you will have £4000 more each year in your fund. By contrast, if you put that £1600 into a property and even if the property price doubles, you will still only have an investment worth £3200 (and that is ignoring the costs of buying, selling and managing the property). So even if your pension investments do not perform brilliantly, you will have extra money you would not have had when buying a property. If your pension fund makes no returns and your property investment doubles in value, you could still be better off in the pension.
Property gains are magnified by borrowing: The big difference, of course, is that you will usually put more money into a property in the first place and also borrow a huge amount extra with a mortgage. So, if the price of the property increases, your gains can be magnified because the amount you have invested is much larger. That works well when property prices rise, but there is no guarantee they will keep on going up and there is also no guarantee that the interest on your borrowings will stay low.
Pension funds can invest in property as well as other assets: It’s also important to remember that a pension can invest in many different assets — including property funds and commercial property. So if you think property will do well, you can include property investments in your pension fund but you can also invest in other assets as well.
Don’t put all your eggs in one basket: When investing for the long-term, it’s not usually sensible to put all your eggs in one basket. Unless you are an expert in one particular area and have ‘exceptional’ knowledge, that you believe is not available to the rest of the market, then relying only on one type of investing means you run huge risks. A more broadly spread portfolio can reduce these risks for you. If you already own a home, its value depends on the movement in property prices. If you then buy another property, you are doubling up. That’s fine when the property market is strong, but there are periods when property doesn’t do well.
Property market may be in a bubble which could burst: Quite frankly, property does have some of the characteristics of a bubble right now – the housing market has been stoked by the Bank of England pushing down interest rates to encourage people to borrow more cheaply, and there aren’t enough homes being built. If borrowing is artificially cheap and there is a shortage of supply, then property prices are bound to rise, but this cannot last for ever.
Investing in property is very expensive: Keep in mind, too, that the costs of buying and managing property can be quite high. You have to pay stamp duty, and you will usually have solicitor, surveyor and estate agent’s fees too. If you let the property, your tenants may not look after it, you will have costs of repairs, you may have periods when it is empty and you could even face court fees if your tenants prove difficult.
Pensions are the most tax efficient way to save for the long-term for most people: You can get tax relief on your pension contributions at your highest marginal rate but you invest in property from taxed income. Any rental income and capital gains from property are taxed, whereas pension investments are tax free. Your pension investments pass to the next generation free of inheritance tax and there is no income tax until the money is taken out (and if you die before age 75 there will be no tax to pay at all). With property, all income and capital gains are taxable and when you pass away your property goes into your estate and is subject to inheritance tax (although there are exemptions for your own private residence).
September 4, 2016 3 Comments
4 August 2016
- Further pain for UK pensions as QE worsens deficits and increases annuity costs
- Bank of England statement completely ignores pension impacts of its policies
- Estimates suggest deficits now approaching £1trillion – this cannot be sustainable
- Government needs to consider help for employers
Today’s decision by the Bank of England to cut short-term interest rates and expand the QE programme is another blow for UK pensions. Both defined benefit and defined contribution pensions have become more expensive as rates keep falling.
Lower rates make pensions more expensive: The amount of money that is needed to pay promised pensions over future decades depends on how much return one is expected to earn on the money set aside for pensions right now. The lower the future expected returns, the more money must be put in today. The cost of pensions, whether Defined Benefit or Defined Contributions, ultimately depends on the returns on gilts. As gilt yields fall following QE, annuity rates fall and pensions become more expensive.
Rises in asset prices don’t offset rise in the liabilities so pension deficits worsen: The sensitivity analysis shows that every one percentage point fall in long gilt yields will increase the average pension fund’s liabilities by 20%, while its asset values will only increase by around 7-10%. Therefore, as gilt yields decline, pension deficits increase and any rise in asset prices is less than the rise in the liabilities or annuity costs.
Deficits are approaching £1trillion: Hymans Robertson estimated that deficits of UK final salary-type schemes post-Brexit had risen to £935billion. A further fall in interest rates as a result of today’s Bank of England announcement will see this figure increase further towards the £1trillion mark. The value of liabilities, as measured at today’s interest rates, is well over £2trillion.
This damaging side-effect of monetary policy means bigger burdens on UK employers: The consequences of rising deficits are that employers struggling to support these schemes face pressure to put in more money. The more money they put into the pension scheme, the less they can spend on supporting their operations. This undermines the aims of QE which is meant to stimulate the economy as this supposedly expansionary policy weakens the ability of the employer to grow its business. So monetary policy that is meant to boost growth has a damaging side-effect that can undermine companies. Ultimately, more employers may fail as pension deficits balloon. That would mean pension scheme members enter the PPF and their benefits are not paid in full.
Trustees caught between a rock and a hard place – need to take more risk, but expected to take less: Trustees of pension schemes, whose deficits keep rising, are facing almost impossible investment dilemmas. They are locked into a vicious circle and struggle to break out. If the scheme deficit has risen, trustees need to consider asking the employer to put more money in to fill the shortfall. But if the employer has already put huge sums in or cannot afford to do more at the moment, then trustees ideally need to find other ways to reduce the deficit. This means achieving better investment returns or reducing the benefits (which is not normally allowed under UK pensions law unless the employer is about to go bust). So trustees would in theory need to take more investment risk, buying assets that can be expected to outperform their liabilities, to reduce the deficit over time. However, in practice, trustees are usually advised to take less risk, not more risk, if the employer is considered less able to fund the deficit. They are told to ‘de-risk’ by buying assets that better match their liabilities.
‘De-risking’ becomes a vicious circle that ultimately increases risk of failure: Trying to ‘de-risk’ generally means buying gilts (or other high quality bonds or hedging), since these are supposed to better match the performance of the schemes’ liabilities. As liabilities are calculated with reference to gilt yields (conventional actuarial basis) or AA corporate bond yields (accounting measure), gilts and bonds are considered the assets that will best match the liabilities. But buying more gilts or bonds will, at the margin, force yields down further, especially in light of further QE (buying £50bn of gilts and £10bn of corporate bonds). Trustees will be competing with the Bank of England for scarce assets and pushing yields even lower and their scheme deficit will keep rising – a classic vicious circle.
Need to outperform liabilities, not just match them and gilts are not a perfect match anyway: In practice, although gilts and bonds may be a closer proxy for the liabilities than other asset classes, they do not actually match liabilities properly. There will still be duration and inflation mis-matching, as well as rising longevity, so even buying gilts may not prevent a rising deficit. And there is a further problem. If the employer cannot manage to meet the deficit payments, the trustees really need to invest in assets that will outperform the liabilities, not just match them, which means taking more risk, not less. They seem caught in a trap at the moment.
Index-linked gilt yields are negative so trustees already face deflation: Pension schemes are facing a further dangerous dilemma in addition to the pure interest rate impact on their liabilities. Index-linked gilt yields have been negative for some time and the more negative the index-linked yield becomes, the more impossible it is for pension schemes to match their index-linked liabilities over time. There are no ‘safe’ assets that pension trustees can buy to match their inflation increases. This further drives them to need to take investment risk. Indeed, this is what the Bank of England specifically suggests it is expecting, however pension schemes have been unable to do so because they are frightened of the employer position weakening further.
Bank of England seems oblivious to the pension impacts of its policies: This is what the Bank said today: “The expansion of the Bank of England’s asset purchase programme for UK government bonds will impart monetary stimulus by lowering the yields on securities that are used to determine the cost of borrowing for households and businesses. It is also likely to trigger portfolio rebalancing into riskier assets by current holders of government bonds, further enhancing the supply of credit to the broader economy.” There is no mention of the effects of this policy on pension funds. In fact, if pension funds are unable to move into riskier assets, the policy is actually going to damage growth in some cases, rather than boost it. Weakening parts of corporate UK is hardly helping the economy. Monetary policy is also risking poorer pensioners in future via the impact on annuity costs. Thankfully, DC pension investors are no longer forced to annuitise too soon if they would rather wait.
Government must address these pension problems urgently: The Government has given some relief to DC scheme investors with the freedom and choice reforms. DC savers are no longer effectively forced to buy an annuity if they want to take just a small amount out of their fund. However, there has been no such relief for employers. If the Bank of England ignores the effect of monetary policy on pension schemes, Government and the Pensions Regulator need to take the issue more seriously. So far, very little has been done to address the stress on employers. I had started some work on this but it did not receive sufficient attention and is even more urgent in light of today’s announcement.
Trustees and employers seem frightened to use flexibilities already built into UK pension system: The UK pension system does have significant flexibilities which could help employers and trustees cope with difficult circumstances, however there seems to have been a reluctance to use the leeway designed to alleviate these burdens.
Must not just help one favoured scheme: The problems of Tata Steel and others have highlighted how many big businesses are simply unable to afford paying the full pension promises at current interest rates. The costs have mushroomed out of all proportion to previous expectations. The British Steel consultation proposed law changes to allow its trustees to cut members’ benefits without consent and even to make them worse off than going into the PPF itself. I believe this would be unwise and set a dangerous precedent. Rather than trying just one favoured employer, the Government needs to look at the whole system. How can employers and trustees manage their liabilities in the best long-term interests of the both the members and the business in light of QE? Too much comment seems to focus on the apparent funding levels as measured today, rather than ensuring the strength of the sponsoring employer to back the scheme in future decades.
In danger of making the best the enemy of the good: Liability management exercises, scheme pooling, longer recovery plans, member consent to benefit changes and benefit streamlining are all possible methods of managing liabilities over time in more affordable ways. Encouraging members with small entitlements to transfer to DC schemes and facilitating small benefit changes such as a statutory over-ride for schemes that need to change the inflation measure used for uprating could provide much-needed relief for many schemes. Offering pension schemes favourable terms for investing in infrastructure and social housing projects could also provide some upside for pensions while boosting the economy. It is time the authorities addressed the serious side effects of monetary policy on UK pensions before more schemes fail. I was working on these issues but there was no sense of urgency, I hope that the new Government will take this matter more seriously now.
August 4, 2016 2 Comments
18 July 2016
- Potential dangers ahead for pensions if responsibility moves from DWP to Treasury
- Could be threats to auto-enrolment
- Must continue to address employer challenges in funding Defined Benefit schemes
It would seem that the role of Pensions Minister is being downgraded by the new Government.
What does that mean?
At the moment, we just don’t know, however it could be that this poses threats to future pensions and we must be alert to the dangers. Pensions are vital for the long-term future of millions of people in our country. We are in the middle of a major programme of reform and it needs to be guided carefully, otherwise there are dangers that pensions policy could be derailed.
What are the risks of downgrading Pensions in DWP?
Pensions Bill: The recent Queen’s Speech contained provision for a Pensions Bill, which I fought really hard to obtain. It is designed to protect pensions. Currently, people’s pensions are at risk if the trust-based DC pension scheme they are saving in winds up. I do hope the new Government will not put these important measures on hold. Members’ pensions are not safe and the protections should have been put in place long ago, they are urgently required. The new Bill would also introduce a cap on the exit charges on members’ funds when they want to move from one scheme to another. At the moment, members can lose over 5% of their money just because they need to move scheme. The new law would cap those charges at much lower levels.
Auto-enrolment: Currently, policy responsibility for auto-enrolment lies in the DWP. If the Treasury takes this over, there are risks to the programme. Auto-enrolment is working really well, as millions of workers are saving in pension schemes for the first time, with the help of their employer. We are establishing as the norm that every employer is expected to provide a pension for their staff. This is a major change but is an essential part of the radical pension reforms that are underway. The new state pension will have no more earnings related elements building up, so all the earnings linked retirement income must come from private pensions or other assets. We must not let the EU referendum fallout derail this vital programme.
Defined Benefit Pension schemes: At the moment, the DWP is responsible for our system of pension protection and there are over 11 million workers saving in Defined Benefit schemes who need a robust protection framework. Funding levels of many schemes have deteriorated sharply, despite employers putting significant sums into them, and the Government urgently needs to address the challenges facing trustees and employers in connection with meeting their pension promises. Work is already underway in the DWP which I had initiated last year and accelerated recently, but it is complex and needs careful handling. A new Pensions Minister needs to engage with this work and manage the issues surrounding the British Steel pension consultation and the knock-on effects on all other schemes.
Pension Wise: Responsibility for Pension Wise recently moved from Treasury to the DWP, to ensure all publicly-provided pensions guidance is located in one place. As DWP was already responsible for the Pensions Advisory Service (TPAS), it made sense to put Pension Wise and TPAS together and form a new guidance body to help people engage with planning their later life income. This was also due to be in the new Pensions Bill and I do hope it goes ahead, even if based within Treasury again, rather than DWP. The public need help and guidance to understand how to plan their retirement income and customer satisfaction with the Pension Wise service has been very high. The new Government must not let this be a casualty of the recent political upheavals.
Bringing private pensions policy under one roof
Last week I suggested to Number 10 that I would be delighted to help the new Government with a radical overhaul of pensions policy responsibility. This could see all private pensions policy joined together in one place, under a Minister in the Treasury, while State Pension policy stays within the Department for Work and Pensions. Indeed, I proposed this to David Cameron last year after he asked me to be Pensions Minister but he decided against it.
I think it makes sense for private pension savings policy to be run in one place, rather than being split across Departments. I would have been happy to do that in the new Government but only based in the Treasury, not the DWP. I wonder if there may be a move in that direction?
Why would it make sense?
As the new state pension means an end to contracting out, the role of the DWP in private pensions is much reduced. Under the old system, millions of people were building a part of their state pension in a private pension scheme, paying lower National Insurance in exchange for giving up rights to part of their state pension. This policy has ended, so the state and private pensions are now totally separate. Therefore, it might be a good time to merge private pension policy together in one place rather than having contract-based private pensions policy resting in the Treasury, while trust-based pensions policy is made in DWP. There are currently two different regimes, one for pension schemes set up under trust and one for pension schemes that are under contract law. Bringing these policies together could help streamline and rationalise the rules, although there would be enormous complexity in doing so.
July 18, 2016 2 Comments
As most readers of this blog will know by now, I have been appointed Minister for Pensions in David Cameron’s new government.
Having spent so many years studying pensions, savings and retirement policy as an independent expert, I have the chance of working inside government to drive things forward. It will certainly keep me busy and be a great new challenge.
Recent years have seen sweeping changes to our pensions system, changes which have started to move pensions in a positive direction for the first time in years. I now have the responsibility of continuing and building on this momentum.
Believe me, I am aware of the hard work that lies ahead. I want to make pensions work better, be more easily understood and more popular. For me, pensions have always been about people, not just about money and I will always try to bear that in mind in my policy deliberations.
We must continue to ensure today’s workers can save for their retirement with confidence. Automatic Enrolment has encouraged more than five million people into a workplace pension – but we still have a further five million to go, as the system continues to roll-out. Opt-out rates have been encouragingly low, but so are the minimum contributions and of course we will need contributions to increase over time.
This is hugely important – most of us can expect to live longer than ever before and must save for our futures if we are to enjoy our later years in relative comfort. I am aware of the challenges of making the second half of the Auto-Enrolment roll-out go as smoothly as the first, and am conscious that the particular needs of smaller and micro employers have to be considered.
It has been really encouraging that the youngest workers have been those least inclined to opt out after being enrolled. But we mustn’t become complacent – we need to do all we can to ensure protective measures are in place to cement people’s trust in their pension investments and encourage engagement.
We need to improve consumer protection and financial education to help people understand more about getting a fair deal and the value of saving. As successful as Auto-Enrolment has been up to now, we cannot just assume the job is done.
I believe passionately that the new pension freedom reforms have made an historic difference in allowing people to make the most of their hard-earned savings. They provide consumer choice for all, not just the wealthiest, rather than forcing most people into buying an annuity that may not be suitable for their needs.
I have been saying for years that we must trust people with their own money – and I believe most British savers will be responsible when it comes to making these long-term decisions. With the help of Pension Wise guidance, improved financial education and ultimately advice, many more people can make sensible decisions for themselves. Encouraging more later life working, particularly part-time, also has the power to benefit many people if they want to increase their lifetime income.
Towards the end of the last Parliament, the Government announced that the new pension freedoms could be extended to those who already have annuities – I very much hope this will become reality.
Next April will see the roll-out of the new State pension. This long-overdue reform will see today’s complicated multi-tiered system of basic and additional State Pensions ultimately replaced with a clearer, fairer, single-tier payment. People need to understand what is happening to the State Pension and we must try to explain it more clearly, despite the complexities of the existing system.
It will benefit many – but it is not yet fully understood. Importantly, it will bring an immediate and significant reduction in the proportion of pensioners on means-testing. I have long warned that we must reduce means-testing penalties, so that people, especially the poorer pensioners, are not penalised for past saving or for continuing to work longer if they wish to. We need to incentivise private provision, rather than penalise it.
And this is all just the start. My in tray is ever growing and I can expect a busy and exciting time ahead. Please give me some time to settle in, consider the landscape and work my way forward with the tasks that need to be done. I will do my very best to help in as many areas as I can, but I cannot make any announcements at this stage and it is not reasonable to expect instant action. It will take a while to assess what is best.
Due to the demands of my new role, unfortunately I won’t be able to maintain this blog for a while. But don’t expect to stop hearing from me!
From inside Government I intend to remain dedicated to championing the rights of consumers and standing up for fairness, while working closely with the industry as we all adapt to the changing pensions landscape. Ultimately, it will benefit everyone involved in pensions if we can find ways to improve customer experience and satisfaction.
It’s an exciting time for the world of pensions and it is essential we continue the progress for today’s pensioners as well as for future generations. I will try hard to make pensions work better for people and hope to be able to make a real difference. I would like to thank all of you who have offered me your support, kind comments and warm words – I will do my best to achieve success.
May 17, 2015 4 Comments
Auto-enrolment increases pension coverage but private sector, especially women, and self-employed lagging behind
30 October 2014
- Pension scheme membership increases as auto-enrolment starts to have an impact
- First increase in pension scheme membership in private sector this century – but public sector workers remain the pensions aristocracy
- 2013 saw 200,000 extra public sector workers saving in pension compared with 100,000 more in private sector
- Still need to address low pension coverage for private sector women (only 30% contribute) and the self-employed (only 22%)
- New pension freedoms may start to increase self-employed interest in pensions again
The latest data for pension scheme membership, just released by the ONS, show some interesting statistics.
1. After years of decline, there was a rise in the numbers of people contributing to pension schemes in 2013. Pension scheme membership reached a record low in 2012, with a massive drop from 8.2million in 2011, to 7.8million in 2012. Last year, the number increased by 300,000 to 8.1million. Of course, this figure is still below the 2011 level, but at least the declining trend has been broken. The table below shows the figures:
Total pension scheme membership
2. Auto-enrolment seems to have reversed the declining trend of membership of private sector schemes. The figures show that, for the first time this century, in 2013 membership of private sector schemes actually increased. In 2011, the number of members of private sector schemes dipped below 3million for the first time, and fell further again in 2012 to just 7.8m, but in 2013 it rose to 8.1m.
Private sector scheme members
3. However, auto-enrolment has had an even greater impact on public sector workers, with a larger increase in the numbers now contributing to pensions. The number of workers in public sector schemes had also dipped in 2012, but the impact of auto-enrolment seems to have increased membership back to the levels of 2011 with 5.3million workers contributing. Membership of public sector schemes still far outstrips that for private sector workers, with nearly 90% of workers covered, compared with much less than half of those working in the private sector. There is a long way to go before pension coverage for private sector workers reaches that of the public sector.
Public sector scheme members
4. Pension coverage in private sector still far too low – around 40% of men and only 30% of women contributing: Between 80% and 90% of those working in the public sector – both men and women – are paying into a pension scheme, whereas in the private sector, even though membership increased in 2013, less than 40% of men and only 30% of women were in pensions. Clearly, the public sector workforce remain the pensions aristocracy.
5. The increased pension coverage did not extend to the self-employed, who continued to turn their backs on pensions in 2013, as numbers contributing to pensions declined once again. The figures are only given as percentages and only for men, but they show the proportion contributing to pensions fell to just 22% in 2013, down from 24% (a previous record low) in 2012 and way below the 62% level of 1996/97. Clearly, pensions are not of much interest to the self-employed. What could explain this? I suspect that the inflexibility of pensions is partly responsible for the lack of contributions. Many self-employed people have chosen to invest in ISAs rather than pensions, since if they need their money they can use it whenever they want. If their business needs some funding, but the money was locked into a pension, they would not be able to use it, whereas with ISAs they can. In addition, the self-employed have no contribution coming from another source. With auto-enrolment, workers receive ‘free money’ from their employer which adds to their pension and that money is only available to them if they contribute to their employer’s pension scheme. This does not apply to the self-employed of course.
Self-employed men, numbers contributing to pension
Tax year end: % of self-employed men contributing
6. New pension rules will make pensions more attractive in future: The 2014 pension reforms could well herald a significant increase in pension participation by the self-employed. By removing the inflexibility of pensions, it is likely that the self-employed will look more seriously at contributing again, rather than using ISAs. Indeed, they may decide to switch some of the ISAs into pensions, due to the tax advantages. Many of those who are self-employed are perhaps also relying on selling their business to fund their retirement, however having a pension in place may be a useful diversification of their risks. The state pension reforms will give the self-employed better pension rights in future, but they will still need more than this for a decent standard of living in later life. It will be interesting to see how the trends in pension membership develop as the pension reform programme progresses. Watch this space!
October 30, 2014 1 Comment
30 September 2014
So many people have been asking me about the new pension changes and what they might mean, I have put together a quick Q&A to address some of these with my comments. Hope you find it of interest. There are profound implications for pension products and pension savers – as well as for regulators of course, to make sure people understand what this all means for them.
- If in good health, perhaps you shouldn’t buy an annuity before age 75
- Look for an annuity with guarantees or value protection
- Pensions have become the most attractive form of savings
- This benefits ordinary savers, not just the wealthy
- More money will go into pensions
- ISAs may switch to pensions
- More money will stay in pensions
- Auto-enrolment more attractive than before
- Pensions can pass down the generations
- Guidance must explain the tax benefits and signpost to advice
- FCA must ensure customers are properly protected
The latest announcement of tax free inheritance for pensions, on top of the Budget reforms already announced, will have profound implications for the future of UK private pensions. It is not putting it too strongly to say that there is a totally different outlook for pension savers in future. This has implications for millions of us, young or older, and it is vital that the new environment is properly explained and understood. So much change has happened which runs entirely contrary to decades of traditional UK pensions thinking that many will find it hard to get their head around the new landscape. Here is quick Q&A to start the ball rolling and hopefully help you appreciate what this might mean going forward.
1. Will these reforms make pensions more attractive?
Unquestionably yes. Pensions are the most tax-favoured and attractive long-term savings vehicle for almost all of us. You could say pensions have become sexy – even exciting! With the new freedom and flexibility, you can save in a pension fund, get tax relief at your top marginal rate, all gains you make are tax free and then any money you don’t use from your fund while you are alive will go tax-free to the next generation. Even your own home suffers inheritance tax, but your pension passes on tax free.
2. Do the reforms just benefit the wealthy?
Absolutely not. In fact, that’s part of the beauty of the new landscape. Pensions are now good for the average earners who can enjoy the kind of freedom and flexibility that used to only apply to the very wealthiest. If you had huge sums in a pension fund before, you did not need to buy an annuity or be limited by capped drawdown, you could use flexible drawdown to take money whenever you wanted, and you could afford not to touch the fund before age 75 so it would pass on tax free to the next generation. Those who had smaller amounts were denied these freedoms but in future they will be available to all. Whether your pension fund is large or small, the Government will not restrict what you can do once you reach age 55 and everyone under 75 can pass on the funds totally free of tax, while everyone over 75 can pass on unused funds to give pensions for the next generation – which will be tax free until they are drawn down and face marginal income tax rates. This ensures many of the advantages that the wealthiest had can now be enjoyed by every pension saver (assuming their pension company allows them to!)
3. Does this have implications for auto-enrolment?
Yes, huge implications. The reforms are likely to mean many more people will stay auto-enrolled and opt out rates should be dramatically lower than previously expected. It also means we should think about auto-enrolling those earning under £10,000 as well, because they are most likely to need the extra savings. As pensions are now so much more flexible and suitable for savers, with the best tax advantages, the reforms make auto-enrolment a ‘must-have’ for many more workers. This is likely to mean higher costs to both employers and the Exchequer than previously forecast. Auto-enrolment is a ‘buy one get one free’ offer. Each £1 the worker contributes immediately doubles to £2 in their pension – due to the employer contribution and tax relief. This is far more powerful than even higher rate tax relief.
4. What does this mean for annuities?
There are several implications for annuities of the new pension landscape.
· More annuities with guarantees, so money can pass on tax free on early death
· More annuities with value protection, as previous sales were hampered by the 55% death tax
· People who are in good health should perhaps delay annuity purchase to age 75
· Standard annuity sales will fall sharply – more impaired or underwritten annuities.
Annuity sales should fall sharply, many will be better to wait till age 75 and the providers will need to offer more guarantees or value protection. Clearly, the reforms will mean the sale of standard annuities, that has dominated the Defined Contribution pensions market for many years, should decline sharply. This is long overdue. Annuities have been sold to people who should never have bought them, or who bought the wrong type of product and the Regulator failed to protect customers properly. The tax system now favours income drawdown and, because of the tax advantages of inheriting pension funds if the saver dies before age 75, there will be a real incentive to delay annuitising until later ages.
5. Won’t people just rush out and spend all the money as soon as they can get their hands on it?
Of course, there is that risk, but firstly I trust people who have been responsible enough to save for their retirement to be responsible enough to manage their funds in later life too. Secondly, with the latest announcement of the scrapping of the 55% inherited pensions tax, there is a real incentive now for people to leave their money inside their pension fund for as long as possible. While any funds passed on were taxed at the penal 55% rate, there was a penalty on keeping money in pensions. Now, in contrast, there is a real reason to hang onto your pension money as long as you can. It grows tax free while in the pension, it’s there if you need it, but if you don’t spend it can pass on tax free.
6. Are there implications for care funding?
Yes, there is now a much more realistic chance that pension funds can help pay for later life care needs, for which no funding has been put in place and which many more people will require. There is a looming crisis in the funding of elderly care, with neither the state, nor the private sector having prepared for this adequately. These pension reforms could kick-start care funding by encouraging people to leave money in their pension funds and then, if they need care, they have the money to pay for it. The state will not pay and cannot pay for all.
7. Does this have implications for ISAs?
Actually yes. The fact that pensions have become so much more tax favoured now suggests many people could benefit from switching ISAs into pensions. The ISA is not free of inheritance tax, it does not get tax relief up front, there is normally no employer contribution and the freedom to spend ISAs has now been at least partially extended to pensions.
8. Will this benefit families?
Yes, this new pensions landscape means people can pass their pensions onto their loved ones and pension savers will know that their hard earned savings can benefit the next generation if they don’t need or use that money themselves. The Government is providing real incentives for people to help their children and grandchildren and improve inter generational wealth sharing. The old system would see insurance companies pocketing the unused funds of most pension savers. Now their families can benefit instead.
9. What does this mean for products?
We will need new types of product – annuities sold from a later age and with more guarantees, so they can be passed on to loved ones. Different products for accumulating pensions, rather than current lifestyle funds that just assume savers will buy an annuity at a preset age. The default will be drawdown, or keeping money invested in the pension fund, rather than buying an annuity so providers need to help savers with better returns for longer periods of time.
10. What about the implications for guidance and regulation?
The new landscape makes guidance even more important than ever. Explaining the tax implications of the pension saving, the implications of taking money out too soon, the tax benefits on death, the benefits of doing nothing and of leaving money invested if still working will all need to be understood. The guidance should signpost people to full advice too. In addition, the Regulator must make sure that customers are properly protected. These reforms are great, but only if people can take advantage of them. Providers must not be allowed to mislead customers into buying unsuitable products, as has too often been the case in the past.
September 30, 2014 4 Comments
28th September 2014
Huge numbers of over 60s are opting out of pensions auto-enrolment, losing their employer contribution
Budget pension reforms make pensions a no-brainer for most older workers as they can simply take the cash if they want to
Need for financial education and advice greater than ever
Figures just released show that nearly all younger workers are remaining in their employer pension scheme after being auto-enrolled, but many older people are opting to leave.
According to NEST (the National Employment Savings Trust) 28% of over 60s are opting out of auto-enrolment, while only 5% of under 30s are turning away from pension saving.
As this week marks the second anniversary of the start of auto-enrolment, it is certainly encouraging that so many are staying in, however it is worrying that the older workers, who will benefit soonest from their pension savings, are not taking advantage of the free money from their employer.
So why are so many older workers deciding to opt out? I can suggest some possible reasons:
- Fear it’s too late to put money into pensions: Many older workers may not have any pension savings at all and may feel they have left it too late. Perhaps they have always heard that it is best to start saving early, so they feel they cannot benefit, while younger workers still have many years of saving ahead of them. However, it’s never too late to save and auto enrolment is a very attractive proposition for most people. Indeed, especially for those who do not yet have much pension saving, staying in auto-enrolment should be beneficial.
- Don’t realise that auto-enrolment means ‘free’ money: Under the terms of auto-enrolment, every £1 that workers contribute to their pension immediately doubles to £2 (less charges) – with the extra £1 coming from their employer and the Inland Revenue tax relief. There is no other savings product which doubles your money on day one. Those who opt out are rejecting ‘free’ money.
- Don’t realise the Budget reforms mean they don’t have to buy an annuity and can spend the money freely: Perhaps the over 60s don’t realise that the Budget changes mean they can double their money and then should be able to take the cash out and spend it after April 2015. As they will no longer have to buy an annuity, or drawdown, they will usually be better off if they stay in
- Fear of means-testing penalties: Some older people may be concerned that having money in a pension will affect their ability to claim means-tested benefits. Certainly, before the pension freedoms announced in the Budget, this could have been an issue, but under the new regime anyone affected should be able to take their money out and spend it, and they will also have the employer contribution to spend as well, which would otherwise be lost to them, so they are better off staying in.
- Already have good pensions: Perhaps many of the over 60s think they already have good pensions in place, so they don’t need any more. However, even if they have other pensions (unless they have reached or are close to the £1.25million lifetime limit), they would normally be best advised to stay in as they are turning away free money by opting out.
- Distrust pensions: Perhaps the older workers distrust pensions so much, after hearing about or experiencing some of the scandals in recent years and this has put them off pensions altogether. Younger workers may be less directly affected by these. It is also the case that new-style pensions are much better value than many older pensions.
- Can’t afford pension contributions: Some older people may feel they need every last penny of their salary and cannot afford pension contributions, however, it is difficult to imagine that so many more older people are struggling than the under 30s, where opt out rates are so much lower. Therefore, this is unlikely to explain the large age differential in opt out rates.
- Don’t believe the reforms will last: Maybe the older workers are more cynical than the young and don’t trust the Government to leave the pension reforms in place, fearing that the freedoms will not last. They may be afraid of being unable to take the money out, or being forced to buy particular products again in future, having seen so many pensions policy changes in the past.
So, if they don’t trust pensions, or don’t trust Government policymakers, this could explain the high opt out rates. It will, therefore, be important for Government and employers to help their older workers understand the benefits of pension saving and the risks of opting out of auto-enrolment if they want to reach those coming up to retirement soonest. Improving financial education would clearly help too. Of course, anyone who is unsure about their position would benefit from taking independent financial advice, but for most older workers, the employer contribution coupled with the Budget pension reforms make pension savings a ‘no-brainer’. Assuming nothing else changes!
September 28, 2014 1 Comment
Lifetime ISA might have been useful in the past but is not necessary now
Pensions auto-enrolment and flexibility will increase pension coverage
New ‘Lifetime ISA’ product proposed, to replace pensions and ISAs: The Centre for Policy Studies is calling for a new savings approach – the Lifetime ISA – to be introduced in the UK. This would replace the separate ISA and pension systems we currently have. The idea is unveiled in this paper http://www.cps.org.uk/publications/reports/introducing-the-lifetime-isa/?utm_source=Michael+Johnson+contacts&utm_campaign=1f6f756838-FTT_chown_lawson&utm_medium=email&utm_term=0_d781b4fd08-1f6f756838-303592833 by Michael Johnson, whose ideas are often worth listening to. Michael is very well-connected in policy circles and has been working on this for several years. The proposals are designed to increase savings levels in the UK, following the dramatic decline in long-term savings, particularly among younger workers.
Pensions coverage will start rising again: It is true that pension coverage has plummeted to record lows in the past few years, and the flexibility of ISAs has proved more popular than inflexible pensions. However, the policy of auto-enrolment under which every worker is joining an employer pension scheme and the new flexibility for pensions introduced in the recent Budget are likely to increase pension coverage significantly in future. The success of auto-enrolment, which relies on behavioural economics to ‘nudge’ people into pensions, coupled with increased flexibility, mean the need to join ISAs and pensions together is significantly lower now.
Tax relief replaced by 50p in £ incentive up to £8000 a year: The proposed Lifetime ISA policy would also mean the end of pensions tax relief, with all savings receiving a 50p in the £ boost from the Exchequer instead (this extra 50p would have to be repaid if money was withdrawn before age 60). A proposed annual allowance of up to £8000 would benefit from this savings incentive top-up, meaning that higher earners would lose out significantly, while the rest of the population received more incentive. In social terms, this makes sense, since one would be redistributing the savings incentives from the highest earners, who presumably need less incentive to save, towards the rest of the population, who probably need incentivising more.
Auto-enrolment offers £1 extra for each £1 contributed, funded mostly by the employer: Tax relief on pensions costs a huge amount – somewhere around £30billion a year – and I suspect the success of auto-enrolment could enable the Treasury to reduce the Exchequer cost of savings incentives in future, while still seeing an increase in pension saving. Indeed, auto-enrolment represents a far more powerful savings incentive than the proposed 50p in the £ for a Lifetime ISA. The auto-enrolment minimum contribution levels offer a ‘buy one get one free’ deal, with an extra £1 going into each worker’s pension fund for every £1 they contribute themselves. Employees put in 4% of their qualifying earnings, the employer contributes a further 3% and 1% more is added by basic rate tax relief, so a 4% contribution immediately doubles to 8%. It is not clear, therefore, whether a 50p in the £ policy is the necessary.
Pension savings can be increased further by auto-escalation: Further ‘nudge’ measures could also be introduced to increase pension savings in future. For example, ‘auto-escalation’ which would encourage people to increase their pension contributions beyond the minimum level, by dedicating a portion of any pay rise to increased pension contributions.
I proposed a Lifetime Savings Account (called ‘LifeSaver’) in 2001 but things have moved on now: Over 10 years ago, I drew up plans for a Lifetime Savings Account, similar to the Lifetime ISA suggestions, which would cater for all a person’s savings needs throughout their lifetime. This is an example from a Paper published in the Journal of Financial Services http://www.rosaltmann.com/pdf/LifetimeSavings_JournalFinServicesJan2003.pdf . I originally suggested that this should be seeded by the Child Trust Funds, which were the forerunner of Junior ISAs. The idea was to ensure people would always have a savings account at every stage of their life. Things have moved on now however. With auto-enrolment, most people will have a pension account once they start work and will also receive extra money from their employer if they contribute. Those who do not save in their workplace pension scheme will forego the employer contribution. The need for a lifetime savings account has therefore diminished and the ability to access pensions flexibly will increase their coverage.
Consider using auto-enrolment for incentivising other types of saving, not just pensions: However, I do think it worth considering allowing workers to use their savings for purposes other than pensions. For example, repaying student debts or saving for a house is a socially valid form of saving, but those who cannot afford to fund debt repayments or house purchase as well as pensions will lose their employer contribution. This seems somewhat unfair. My suggestion is that anyone who saves will receive an employer contribution, but the worker’s own money could be used for purposes other than pensions, while their employer contribution and the basic rate tax relief stay locked until later life.
This would mean everyone saving for their future in some form, with the help of their employer, rather than only offering employer assistance for a pension product and nothing else.
In summary, I am not convinced that we need a new Lifetime ISA. I believe pensions coverage will increase significantly as a result of the policy changes already underway. However, I do believe there is merit in extending the savings incentives to cover other forms of savings beyond just pensions. Those saving for a house or who want to repay student debts should still receive an employer pension contribution, but this employer money and basic rate tax relief should stay locked until retirement, while the worker can access their own savings if needed.
August 4, 2014 1 Comment
20 May 2014
- New Budget flexibilities dramatically increase appeal of pensions auto-enrolment
- Opt out rates should fall significantly
- ‘Buy-one-get-one-free’ deal too good to miss for most
The Pensions Policy Institute has today published new research highlighting that auto-enrolment is now far more attractive than previously expected.
Opting out of auto-enrolment is turning down free money: Even for older workers, who were the group least likely to benefit from staying in their employer’s scheme, the flexibilities introduced to pension savings in the 2014 Budget will mean those who do opt out will be turning away free money. As the PPI says, unless they are really in dire straits, it is hard to see why they would want to refuse their employer’s pension contribution and the tax relief.
Pensions are far more attractive now so opt-out rates should be much lower than expected: The new flexibilities in the UK pension regime will dramatically increase the appeal of pension savings and employers should be prepared for much lower opt-out rates than they might previously have budgeted for.
Older workers will be first to benefit: As workers will all be entitled to take their pension funds as cash from April 2015, if they want to, the pension savings under auto-enrolment have become significantly more attractive, especially for older workers who could be the first to benefit from the pension reforms.
Taking the funds as cash removes the previous risks to older workers: The new rules remove the problems of pension saving for older workers, who might previously have been at risk of either just tipping over the old limits for cash withdrawals. These ‘trivial commutation’ and ‘small pots’ limits will be swept away in 2015, so pension savers will be able to take their auto-enrolment pension fund and spend it if they wish. In addition, there were previous concerns that older workers would find their pension income resulting in lower means-tested benefits, but now that they will be able to take their fund as cash and spend it, it will not need to count against their means-tested benefits. In any event, fewer pensioners will be subject to mass means-testing, as the new state pension rolls out after 2016, so the amount of money built up in an auto-enrolment pension fund will be more likely to improve people’s retirement finances.
Auto-enrolment offers a ‘buy-one-get-one-free’ deal: Therefore, any workers who do opt out will be turning down free money from their employer. The auto-enrolment regime offers a ‘buy one get one free’ deal on pension contributions. For each £1 the worker puts into their workplace pension scheme, another £1 goes in (75p from their employer and 25p from the tax relief). Unless they have huge debts, it will normally make financial sense to remain in the scheme, even at older ages – or perhaps especially at older ages – because they will be closer to the point at which they can access the money if they need to. If they do not put that £1 into their workplace pension, they will not get the extra 75p from their employer, nor the 25p tax relief. Indeed, even non-taxpayers can benefit from the tax relief and can request to join their employer’s scheme.
Employers should be prepared for majority of workers to stay in: The new rules will be a gamechanger for future pension contributions under auto-enrolment and employers will need to be prepared for the vast majority of their employees to decide to stay in.
May 20, 2014 No Comments
27 March 2014
Charges cap is important to protect smaller firms’ workers
Will eventually need to control all charges, not just AMC
Disappointing that NEST two-tier structure will continue to prevent easy comparison
- 0.75%pa charge cap on auto-enrolment default funds from April 2015
- Banning penalty fees on leavers from April 2016
- Banning commission payments from April 2016
- As auto-enrolment spreads to smaller firms, their workers need protecting from high fees
- Pot follows member can’t work without a control on fees
- Full disclosure of all other costs, including transaction costs, by 2017
- Ultimately need cap on TER, not just AMC otherwise providers can just circumvent the cap
- NEST’s charge structure doesn’t fit with a cap – shame it will not have a single annual charge to allow customers to compare costs properly
Cap on charges from April 2015: As the Budget measures that rocked the pensions industry begin today, another major piece of the pension reform jigsaw is put in place. Pension providers will have to improve their practices, and while they are still reeling from the ending of captive annuities and introduction of new flexibility, the Government announces its long-awaited cap on pension charges.
0.75% charge cap is at lower end of proposals: Steve Webb has decided to introduce a cap on the charges for default funds in new auto-enrolment pension schemes. Having consulted on a cap of 0.75%, 1.0% or no cap at all, the DWP has decided to go for the lowest figure. The cap will be introduced from April 2015. The average Annual Management Charges (AMC) for all trust-based DC schemes are currently around 0.8%. Pension providers will therefore have another change to cope with, in order to improve the way they treat their customers.
Charges can significantly deplete pension funds: It is important to cap charges on pension funds. The impact of charges on pension savings may be small in each individual year but are significant over a lifetime. DWP figures show an auto-enrolled worker on average earnings, contributing for 46 years will pay charges that amount to 13% of their fund with a 0.5% annual charge, 19% of their total fund if charges are 0.75% pa, 24% of their fund with a 1% charge and 34% of their fund will go in charges if there is a 1.5% AMC as shown below:
Charge level per year
% reduction in final fund
Cap will not apply to all costs though: So far the 0.75% cap only applies to the Annual Management Charges (AMC). AMCs cover asset management costs but exclude many other ongoing charges such as legal fees, administration and accounting and do not include transaction costs. The OFT identified 18 different charges that have been imposed on pensions. These additional charges can add significant extra sums to the costs of workers’ pension schemes, therefore it will be vital to include other charges in any long-term cap. Initially, the DWP will require full disclosure, then once the evidence of the level of extra charges emerges by 2017, the cap may be changed. Capping Total Expense Ratio (TER or Ongoing Charges) would ultimately be better than AMC to prevent providers simply circumventing a cap with new charges.
Government is right not to be lulled into false sense of security by low charges for new schemes: The OFT recently found that new auto-enrolment schemes have average AMC of just 0.51% with multi-employer schemes even less, so some say that a cap is not required. However, it is important not to be lulled into a false sense of security. So far only the larger employers have auto-enrolled. These employers have the wherewithal to negotiate good terms for their workers, and more management time to devote to these issues than smaller employers starting auto-enrolment in the next few years. Most micro employers have no experience in pensions and providers will be less keen to compete for their business so there would be a danger of much higher charges.
As auto-enrolment proceeds, workers in small employers need protection: DWP figures confirm that members in smaller schemes, with low paid workers pay higher charges, so as smaller firms are brought into auto-enrolment, the need to protect workers from high fees is clear. Average AMC for smaller schemes (12 to 99 members) were 0.91%, compared with only around 0.5% for larger schemes (over 1000 members).
Principal agent problem – employers choose, but workers pay : It is important to control charges to protect workers in new auto-enrolment schemes. Unlike traditional Defined Benefit schemes, where employers covered all the management costs, members must cover these in Defined Contribution (DC) schemes. However, their employers choose the scheme they are auto-enrolled into, so members are in a weak position to protect their own interests. The OFT expressed concerns about this principal-agent problem. A charge cap will provide some protection for workers as they cannot choose or change the scheme their employer uses.
End of Active Member Discounts – about time too!: So-called ‘Active Member Discounts’ (AMD), which, in reality, are penalty charges on people who have left their employer scheme will be banned from April 2016. These penalty charges are particularly damaging for many women who need to take career breaks for caring responsibilities. When they leave their employer scheme they face much higher charges which the OFT estimated could be almost an extra 0.5%. 94% of pension schemes that have AMDs are still open for auto-enrolment so it is important to ensure they are ended. The industry is being given an extra year to make the changes. The Government’s current proposals for ‘pot follows member’ will not work unless there is a clear minimum standard for all auto-enrolment schemes.
Ban on commission-based fees : From April 2016, the DWP will ban all commission based schemes. This will help reduce pension fees for many schemes, since where employers use a commission-based advisor, charges were on average 0.4% higher. The industry will, however, have to retrospectively change those schemes that have already been set up on this basis.
NEST charge structure undermines effectiveness of any charge cap: The charge structure of the taxpayer-backed NEST scheme does not properly fit with the aims of a simple charge cap. For a charge cap to work most effectively, customers must be able to easily compare schemes with each other. Two-tier charge models make this difficult. NEST has an initial contribution charge of 1.8% plus a 0.3% AMC annual fee, while NOWpensions charges an £18 initial fee, plus 0.3% AMC – these cannot easily be compared with schemes that have a TER of 0.5%. The Pensions Policy Institute calculates that older workers in NEST are particularly disadvantaged. Those who are auto-enrolled at age 60 and contribute until their state pension age will pay far more in charges with NEST than with a 0.75% cap. As it is older workers who will retire first under auto-enrolment, it is disappointing that reform of NEST’s charges has not been included.
Need for a measured approach: Introducing an immediate cap for schemes already set up could interfere with roll-out of auto-enrolment and divert industry resources away when they will be vitally required to service the coming capacity crunch in the industry. Therefore, allowing some time for the cap to fully develop makes some sense and will give providers time to cope with new demand while also adapting older schemes.
Overall a cap will help make our pension system more user-friendly: The introduction of a charge cap, following on from increased flexibility and auto-enrolment, should help restore confidence in pensions as a fair long-term savings vehicle. Labour has been calling for such a cap on TER, not just AMC, which would be even better for members and this may yet come.
March 27, 2014 1 Comment