Category — Savers and Savings Policy
20 April 2017
Help poorer pensioners, older women and families facing elderly care
- Radical overhaul of social care to ensure fairer system for all – a crisis worse than pensions
- State Pension triple lock could move to a double lock, increasing by prices or earnings
- Double lock should apply to Pension Credit so poorest pensioners are protected properly
- Improve pension outcomes for women – private pensions, State Pensions and WASPI
- Reform pensions tax relief to give everyone a 33% Government bonus on their contributions
- Encourage longer working life – mid/later-life training, career reviews, apprenticeships
Government plans for Brexit and the economy will dominate many people’s thinking, but a coming Election Manifesto needs to cover other important issues that will affect the lives of older voters significantly. Here’s some initial thoughts – a six-point plan to improve older people’s lives, while giving a more affordable, sustainable and fairer system for the future.
Here are my suggestions:
- Radical overhaul of social care to ensure fairer system for all
In terms of fairness, it is absolutely vital that the Government finally addresses the ongoing and worsening crisis in social care. The current system penalises elderly people and their families and lowers care standards, while raising the costs to those paying privately. It is undermining the NHS and places the biggest burdens on those who fall ill, rather than being shared fairly. There is no help for the poorest people with moderate needs, which makes it more likely that they end up in hospital or care homes and lose their independence.
Meanwhile, older people who do have savings have to lose everything, including the value of their home, before they get any state help at all. The draconian means-test coupled with council cutbacks, on top of rapidly rising numbers of elderly people in our aging population has caused huge strain on the social care and health services, undermining the quality of social care (such as only allowing 15 minute visits and low paid staff on zero hours contracts). The system is riddled with unfairnesses and is simply not fit for the 21st Century. Private payers who are denied state help end up paying over the odds for care, to make up for local authority underpayment. This penalises those families who are unlucky enough to need elderly care twice – firstly they get no help from the State and secondly they also have to pay extra to cover the costs of those who are covered by the State.
This amounts to a most inequitable stealth tax, hitting the most vulnerable in society. To add further to the unfairness, elderly people who are judged to have a health need, rather than social care need, will have all their care costs met by taxpayers. This arbitrary allocation of resources is unsustainable and is placing the NHS under intolerable strain, even before the huge bulge of baby boomers reaches advanced old age. Proper integration of health and social care is long overdue. It is obvious that the State cannot pay to look after all baby boomers who will need it in coming years.
There is no money set aside for this purpose and younger taxpayers will be unable to afford it. Therefore, incentivising those older people who have pensions, ISAs or other savings to earmark a sum to pay for care, while the State then covers the extra on top of that, would kick-start funding which is currently non-existent. Introducing a Dilnot-style cap on care costs, then allowing tax free withdrawals from pension funds if needed to pay for care, plus introducing a special Care ISA allowance (that can be passed on free of Inheritance Tax) or allocating some proportion of property value up to a limit of, say, £70,000 per person, would ensure baby-boomers have incentives to prepare for their coming care costs, while also signalling that everyone will need to think about providing for care in old age, as well as pensions.
- State Pension Triple lock could move to a double lock, increasing by prices or earnings
The triple lock commits to increasing (only some parts of the) State Pension by the highest of price inflation, average earnings or 2.5%. The 2.5% commitment contained in the triple lock adds billions to the cost (it is estimated that State Pension has cost £3billion more for the years 2010 – 2016 than if a double lock had been in place).
The longer the triple lock lasts, the greater the future cost will be, with official forecasts predicting it will add at least £15billion to the long-term cost of State Pension provision. The arbitrary 2.5% figure is a political construct with no economic or social logic. When it was introduced, the State Pension had fallen well behind average earnings, so it served a useful function in increasing basic State Pensions to a more reasonable level. But pensions have increased significantly relative to other benefits.
The Pensions Commission recommended only increasing State Pensions in line with earnings, but perhaps the Government should offer pensioners the higher of prices or earnings inflation, as a double lock, to protect against rises in the cost of living and average living standards of those in work. If other benefits are being frozen, or only protected by either prices or earnings, to add the extra 2.5% protection for pensioners will cause increasing resentment and also adds to pressure to increase the State Pension age faster, which disadvantages those with lower life expectancy and in poorer health. In addition to this, the new State Pension system has rendered the triple lock concept socially inequitable.
- Double lock should apply to Pension Credit so poorest pensioners are protected properly
The triple lock, in fact, contains inherent unfairness which will worsen in coming years as more younger pensioners receive the new State Pension. The triple lock does not actually protect many of the poorest and oldest pensioners because does not cover all State Pension payments.
It only applies to two bits of State Pension – the old Basic State Pension (up to around £120 a week) and the full new State Pension (up to around £160 a week, but only available to the youngest pensioners). Most importantly, it does not apply to the Pension Credit (which the poorest pensioners receive). A much fairer system would see the double lock protection extended to Pension Credit to help the oldest and poorest pensioners.
- Improve pension outcomes for women – private pensions, State Pensions and WASPI
Women lose out in pensions in many different ways and, although the Government has made some improvements, both State and private pensions policies still discriminate against women. As regards private pensions, women are losing out in workplace pensions. There are several reasons for this.
The gender pay gap means they earn less than men, so their pension contributions will be lower but recent studies also show that women work in jobs with lower employer contributions and on average their employers pay 1% of salary less into their pensions than for the typical male. Women also take career breaks which reduce their lifetime earnings. In addition to these factors, women are also losing out in auto-enrolment as they are more likely to be low earners.
Only people earning over £10,000 a year in any one job are auto-enrolled by their employer. So these lower earners lose out on their employer’s contribution and on the behavioural benefits of being automatically enrolled, even though they are the people who would probably most need better pensions and the behavioural nudge of being automatically enrolled. Many women work in multiple low paid jobs, in order to fit their work commitments around caring responsibilities. Even if these women’s total income is above £10,000, if they earn less than this in each job, they lose out on auto-enrolment completely.
The Government estimates that over 70,000 women are affected. These women are also more likely to be losing out in State Pensions too. The cracks in the National Insurance system penalise far more women than men. Those earning less than £5,876 a year in any one job get no credit for their State Pension, even if they have multiple low paid jobs that would bring their earnings over the National Insurance threshold. The Government estimates 20,000 -30,000 women are affected and they get no credit for their State Pension.
In addition, women who have children but are in households with incomes that disqualify them from Child Benefit have to claim the benefit even if they know they’re not entitled to it, otherwise they lose out on their State Pension credit too. All these wrinkles in the National Insurance State Pension system should be removed, so that women are no longer discriminated against in these ways. Finally, there are many WASPI women who were not properly notified of changes to their State Pension Age. The Government should recognise the hardship its failure to communicate properly has caused and should ensure those affected are able to receive some early payment, to compensate for the short-notice increase in pension age which they did not have time to prepare for.
- Reform pensions tax relief to give everyone a 33% Government bonus on contributions
The Government decided not to reform the current system of pensions incentives, that revolves around tax relief. The present arrangements are not understood by the majority of people, who don’t realise that 20% tax relief gives them a 25% Government bonus on their pension contributions, while higher rate taxpayers get 40% tax relief, which is a 66% bonus on their contributions.
Instead of confusing people with a Lifetime ISA that could also be used for house purchase, the Government should introduce a fairer system of pension incentives shared more fairly, with a 33% Government bonus being offered to everyone. The annual contribution limit would need to be cut from the current £40,000, and the Lifetime Allowance should be reformed or abolished. The freedom and choice reforms have made pensions the most attractive retirement saving option, but if the Government is serious about helping those in the middle or less-advantaged positions in society, then making the pension system fairer for all should be a priority.
- Encourage longer working life – mid/later-life training, career reviews, apprenticeships
If the Government is serious about controlling immigration, given the aging workforce it will also need to ensure that more older people stay engaged in the labour market than ever before. This will need a radical rethink of workplace practice, as well as greater encouragement of mid-life training, career reviews and apprenticeships.
Those who can and want to work flexibly as they get older should be supported positively, with employers required to ensure age is no barrier to ongoing training and re-skilling opportunities. Businesses should take the value of older members of their workforce more seriously and unlock the potential of older workers. This can boost the economy both now and in future, as people have higher lifetime incomes and opportunities to build up better pensions.
April 20, 2017 10 Comments
5 April 2017
- Launch of Lifetime ISAs – don’t be fooled
- Hardly any providers offering LISAs – probably due to complexity and mis-selling risks
- Mixing house purchase and pensions will damage ISA brand
- LISAs may be good for first time buyers, but dreadful for retirement – saving for house deposit very different from long term investment for retirement
- Trying to turn pensions into ISAs undermines young people’s pension prospects
- Why not just improve the Help To Buy ISA and leave pensions alone?!
The new Lifetime ISA launches tomorrow. Thankfully, most providers have steered clear of it, they can see the dangers. Don’t be misled. If you want to buy a first home and are saving for a deposit, then the 25% Government bonus is a great deal. But using this as a pension has significant dangers you may not be aware of. Most providers are shunning Lifetime ISAs due to fears of mis-selling. They are right. This is a complex product which could leave millions of young people poorer in retirement. It has mis-buying and mis-selling risks written all over it! There is already much confusion and the Pensions and Lifetime Savings Association (PLSA) suggests many young people are considering opting out of their workplace pension to save in a LISA instead. That could undermine their future prosperity, so it is important to clarify some of the biggest issues.
- LISA gives you much less than workplace pensions: The 25% Government bonus is exactly the same as 20% pensions tax relief so you will not get any more money in a Lifetime ISA than you would in a pension. However, you will lose out on other money if you opt out of pensions and choose LISAs instead and you need to understand this before you decide.
- Pensions give you much more than just a 25% bonus: Workplace pensions can give you extra money from employer contributions, higher rate tax relief and National Insurance relief. This could be more than 100% bonus on your money, so pensions will usually give you far more than the Lifetime ISA on day one. It’s just that this is not properly explained when you get your pension statement, so most people don’t realise it.
- The 25% withdrawal charge is NOT just clawing back the 25% bonus. Many people do not realise how the LISA works and will believe they just lose the Government bonus. It’s much more than that.
- The LISA charges more than 6% penalty if you want your money back: If you put £4000 into a LISA and get the £1000 Government bonus but then want to take your money out again, the 25% withdrawal charge will be £1250 (and you will have to also pay charges for your LISA account too of course). That means you will get less than £3750. You will be charged more than £250 just to get your own money back – a large extra penalty.
- Mis-selling and mis-buying risks are clear – customers need advice: LISA providers may not clearly explain the risks of the large withdrawal penalties, and how much money young people will lose if they opt out of employer pensions. The FCA is trying to ensure risk warnings are given, but in reality the provider should check that customers have not opted out of workplace pensions, or have taken financial advice, so they have made efforts to check if a LISA is suitable for them.
- Saving for a house deposit in cash is fine, but cash is not suitable when investing for retirement over several decades: It is dangerous and misguided to conflate saving for a deposit on a first home, with investing over several decades for retirement. House purchase saving can be in cash, but long-term investing should be in growth assets and a broader spread of risks, including overseas investment, which would not really be suitable for a house deposit, but which can give better returns over time. Most ISAs are held in cash and, if pensions are turned into ISAs that are just put into cash accounts, young people are likely to be much poorer in later life.
- Serious risk of undermining the success of auto-enrolment: Pension coverage has spread to millions of new workers as employers have to put all staff earning above £10,000 a year into a pension scheme at work. But worrying PLSA research suggests many young people may opt out of their workplace pension, without realising how much they’d lose by doing so. Just as auto-enrolment is proving a success, along comes a new product to confuse things. It is not true that people don’t like pensions, auto-enrolment opt-out rates are really low, especially among the young. I am pleased that so few providers are offering this product because most young people will be better off in retirement if they use a pension.
- Behavioural nudges of Lifetime ISA are not suitable for retirement saving: The Lifetime ISA has behavioural features that make it far less suitable for retirement saving than a pension. Pensions are designed to fit with the principles of behavioural economics, while ISAs have perverse incentives.
- Pensions ensure more money goes in on day one. Auto-enrolment takes advantage of inertia as well as ensuring employers have to contribute too, so people have more money to begin with in pensions than in LISAs.
- Pensions are locked in until later life, while LISA does allow withdrawals. However, withdrawals face the stiff penalty of over 6%, leaving people with much less in their fund along the way.
- Pensions are taxable on withdrawals beyond the 25% tax-free lump sum in later life. This deters people from spending the money too soon, which is the right behavioural incentive. The incentive with a LISA will be to take all the money out around age 60, and have nothing left for your 80s – in other words, the features of the Lifetime ISA mean it is designed NOT to last a Lifetime.
- Pensions could even help pay for later life care. Pensions encourage people not to spend their money too quickly and, because they pass on free of inheritance tax, there is no need to worry about keeping it till much later life – so it could even help fund care needs if necessary. Young people will have much poorer retirement prospects with LISAs than pensions.
- Lifetime ISAs are great for the wealthy but will cost taxpayers an extra £1billion – is that money well spent? At a time when bereavement and child benefits are being cut, the LISA is going to cost an extra £1billion to the Treasury in the next few years. Two groups of people will most benefit from using a LISA for retirement saving. Firstly, wealthy under-40s who have already filled their pension allowances (perhaps they already have £1million of pensions or have contributed up to the £40,000 maximum into pensions). Secondly, non-earning relatives of wealthy people who have already put the maximum £3600 into a pension for them to get the tax relief and will now get a further taxpayer top-up for an extra £4000 for them. Is this a sensible use of taxpayer resources?
CONCLUSION: Lifetime ISAs should be abandoned. Stop confusing young people between retirement investment and saving for a house deposit – just reform the Help To Buy ISA and build on the success of auto-enrolment for pensions. The product is too complicated, will confuse customers and the last thing we need is another mis-selling scandal.
April 5, 2017 No Comments
8 March 2017
Another missed opportunity to start addressing social care
- No new incentives for social care savings and radical reform proposals pushed into Green Paper later this year
- No proper help for savers – new NS&I bond pays interest rate lower than inflation, so savers lose money
- Costs of public sector pensions will rise sharply, by nearly 40% between 2015 and 2020
- Self employed bearing brunt of tax rises to pay for other measures
Addressing Social care crisis:
- Extra £2billion for social care will help councils but may not be enough to ensure NHS pressures really relieved.
- No new help or incentives for families to save for social care or use their ISAs and pensions.
- More money for councils to cover costs of social care is good, but proper reform delayed – more money is just a sticking plaster on a weeping wound.
- Will be a Green Paper later this year on radical structural long-term reform. That’s good but needs to be followed by urgent action as care system is breaking the NHS. Integration of health and care, helping families prepare for care costs, finding ways to recover extra money to pay for care – all these are essential as our population ages. The number of people over age 75 will increase by 2million in next 10 years.
- No help for families to start saving for care – no incentives to help them save even though ‘death tax’ ruled out so can’t take money from their homes or estates.
Measures for savers
- No new help for savers even as savings ratio reaches such low levels
- New NS&I bond pays only 2.2% interest while inflation forecast to be 2.4% this year and 2.3% next year, so savers lose money in real terms each year
Helping people extend working lives
- The Chancellor has announced £5million extra money for returnships for adults trying to get back into work. This is potentially good news for older people and other adults trying to return to work, especially helping many older women and carers who want to work after taking time out for caring. Of course, more is needed but this is a start. For example, if each returnship costs £250, this can help 20,000 people.
Pensions flexibility is raising far more money for Treasury than originally forecast.
- Treasury expected pension flexibility to raise £0.3bn in 2015-16 and £0.6bn in 2016-17, but people have taken higher amounts out than previously forecast, so actual tax receipts were £1.5bn in 2015-16 and £1.1bn in 2016017. One cannot draw many conclusions from this as we do not know what the people who withdrew money will be doing with it – whether they have other pensions elsewhere and are repaying debts and so on. The Government needs to conduct some proper research into what people are doing when withdrawing pension money. Expected revenues from pension flexibility rules are expected to be £1.6bn in 2017-18 and £0.9bn in 2018-19. Again, we cannot draw firm conclusions without further information.
Costs of public sector pensions set to rise sharply.
- The Budget figures list the costs of public sector pensions as follows. In 2015-16 the cost was £11.3bn but by next year that will have risen by over 20% to £13.7bn. By 2021-22, the cost is forecast to rise to £15.7bn, which is an increase of 39% over the 2015-16 level.
- 2015-16 £11.3bn
- 2016-17 £11.5b
- 2017-18 £12.1bn
- 2018-19 £13.7bn
- The Government is continuing its clampdown on overseas pensions. Anyone who wants to move their UK pension offshore into a ‘Qualifying Registered Overseas Pension Scheme’ (QROPS) will have to pay a 25% tax charge on the funds transferred, and also any payments made from the QROPS in the first five years after the money is transferred will be taxable in the UK.
March 8, 2017 1 Comment
4 January 2017
- UK private pensions are in mortal danger – their huge benefits seem under threat
- Anyone who cares about pensions should be very, very worried
- Latest Treasury info doesn’t mention pensions when educating the public about retirement saving
- Future generations face worse later life income if Treasury succeeds in undermining pensions
- ISAs are sub-optimal way to provide for later life and will saddle future Government with rising pensioner poverty – pushing more costs onto the young
- Now is the time to promote the benefits of pensions so people understand
The Treasury has just released an infographic for the public, which shows how to save throughout the lifecycle, but doesn’t mention the word ‘pension’. This is further evidence of the concerns I have expressed before about Treasury attitudes to pensions. It suggests that our private pension system is under existential threat.
Treasury sees pensions as a cost, but they are a real benefit to millions of people: During my time as Pensions Minister, there was clearly a difference of view between Treasury and DWP about private pensions. The Treasury sees them as a cost to the Exchequer. DWP sees them as a benefit for people to give them a better later life standard of living. That is how most people see them and why they are so important.
Treasury trying to promote ISAs but who is promoting pensions?: Having battled against the Lifetime ISA, it is deeply troubling to see the latest public information from the Government, talking about ‘ISAs and other savings options’ which omits to mention pensions when saving for retirement. The huge advantages of pensions are totally ignored.
Anyone using a Lifetime ISA, instead of a pension, is likely to end up with less in later life: Private pensions are far better than ISAs in terms of their behavioural design. Using a pension, instead of a Lifetime ISA, should ensure you have more money in later life. Future Governments will have to deal with the consequences of more poor pensioners, and greater strains will fall again on younger generations.
Pensions have many advantages over ISAs: Pensions can give you free money from your employer, more Government contribution to your savings, controls on the charges, better investment options for long-term growth and behavioural nudges to stop you spending the money too soon. The pension can pass on tax-free to your loved ones, or can keep growing as you get older and provide a fund to help pay for care if you need it as you get older.
Using ISAs will mean less money in later life: ISAs are more likely to be held in cash (giving lower long-term returns), have no controls on charges and encourage you to take all the money as soon as you can, unlike pensions which have incentives to stop you spending the money too quickly.
The big problem with pensions is that many people do not appreciate their huge benefits: It is time for the pensions industry to start promoting the advantages of using pensions to provide for later life. We need an advertising and marketing campaign to tell people why pensions are so valuable, we can’t assume everyone knows. Just saving in cash in an ISA is not a good way to provide for later life.
If you care about private pensions and believe they are worth fighting for, now is the time to stand up and shout about their benefits: Before it’s too late and they are supplanted by an inferior product because of short-sighted policymaking that will leave long-term dangers.
January 4, 2017 1 Comment
14 December 2016
Jeremy Hunt is right we need for private savings to help fund care crisis
- There’s no one solution but private savings must be part of the mix
- Care costs much higher for older women than older men
- Government can introduce tax incentives to help families save for care costs
- Care ISAs, Workplace Saving Plans, Eldercare vouchers, Family Care Saving Plans free of Inheritance Tax
- Consider using auto-enrolment and free Guidance to kick-start care savings as part of 2017 auto-enrolment review
Jeremy Hunt is right – people will need private savings to help fund later life care: Politicians have talked about social care for years, but have ducked the difficult decisions required to address this time and again. Despite knowing that numbers needing care will rise inexorably, policymakers have not set aside public money, or encouraged private provision to pay for care. The quality of care has suffered, many companies cannot afford to deliver decent care within the council budgets, and the screaming headlines from recent days continue to highlight that this crisis is just getting worse.
There is no money set aside for care: There is almost no money earmarked to pay for the care people will require – not at public or private level. Estimates suggest that around half the population over age 65 will need to spend at least £20,000 on later life care, and one in ten will spend over £100,000.
Problem is worse for older women than for men: The CII Report released yesterday on Risks in women’s lives found that this is a much worse problem for women. The median man over age 65 will need to spend around £37,000 on later life care, but the median woman will need around £70,000. Where will this money come from? It either has to come from councils on a draconian means-tested basis, or the NHS (when early intervention or prevention is not funded), or individuals and their families who suddenly find themselves faced with huge spending they had not prepared for. And of course older women are less able to save for their future needs because they are more likely to have to cut down or stop working to provide care for loved ones – society takes this free female caring for granted.
Families will need to prepare for some costs, but they need help. Local authority care funding is subject to one of the strictest means-tests. Most people will receive no help from the state until they have used up the bulk of their assets (down to £23,250) and until their needs are considered ‘substantial’, causing significant distress to many families and leaving the majority of families without the care their loved ones or they need. Many suddenly have to find significant sums at short notice. Ideally, money is needed for prevention and early intervention, so that people can have a little help or pay for measures that will ensure they are safer and less likely to fall. But they need to know what to do.
Products for care funding are inadequate. There are some products already on the market to help people pay for care but they are expensive and will not help with prevention. These include Immediate Needs Annuities, Equity Release and local authority deferred payment plans, but each has advantages and disadvantages and they only help at the point of need, rather than allowing people to make plans in advance.
Encouraging saving for care could help. It seems that Jeremy Hunt may be signalling that at last the Government recognises the importance of helping families prepare for social care costs in advance. People don’t know they will need such sums, but if they spend all their pensions or ISAs before they reach their 70s and 80s, they may really regret not being able to pay for the help they need. I believe Jeremy Hunt is correct, some private savings will have to be part of the mix. 21st Century retirement income is about more than just pensions.
Extra tax breaks to encourage long-term care saving. We spend around £40billion on incentives for pension saving and not a penny on incentives for social care saving. 21st Century retirement needs more than a conventional pension to help fund later life. Providing taxpayer incentives and employer incentives is important because the cost to society of failing to ensure money is set aside for future social care needs will put intolerable burdens on the NHS and on younger generations as well as on older people. Urgent action is needed to head off a disaster that is clearly on the horizon.
Care ISAs – IHT free: The Government could introduce a separate annual allowance for ISAs that are specifically earmarked to pay for care or allow people to transfer existing ISAs. Launching such ‘Care ISAs’ would itself help people realise the need to save for care. It could allow up to, say, £50,000 or £100,000 per person to be earmarked for care spending and such Care ISAs could be passed on free of inheritance tax to fund Care Savings for the next generation too.
2017 review of Auto-enrolment could consider encouraging workplace care saving plans: Alongside auto-enrolment, it might also be helpful to ensure that employers are encouraged to offer the option for people to save in a workplace savings plan that is set aside specifically for care.
Workplace Saving Plans and flexible benefits packages to include eldercare: The Government needs to incentivise employers to help staff prepare for care costs. This can include savings plans to build up a fund to cover care costs, and also such ideas as eldercare vouchers, along similar principles to childcare vouchers. Employers can help their staff pay for someone to look after elderly loved ones, rather than having to leave work or suffer stress when such help is not available. This could be part of a flexible benefits package, which receive an employer contribution.
Family Care Savings Plans – IHT free: Another possibility is for families to save collectively for the care needs of their loved ones. For example, parents, siblings or children might join together to build up a fund in case one of them needs care. The probability is that one in four people will need care, but nobody knows in advance which one. Tax breaks to incentivise this kind of saving, perhaps allowing them to be passed on free of inheritance tax, would help. There is a role for insurance with such savings plans – which might also include some ‘catastrophe insurance’ to pay out if more than the expected number in any family or group actually need care.
Tax free pension withdrawal if used for care: The new pension freedoms could encourage people to set aside money for later life care. Now that the annuity requirement has been removed, and there is no 55% death tax, pension funds could help cover care costs. Many people reaching retirement have tens of thousands of pounds in their pension funds but if they use this to buy an annuity, they will have no money to pay for care. Allowing people to withdraw money from their pension fund without paying income tax, if it is to pay for care, would encourage them to retain some funds in the tax free pension wrapper for longer, just in case it is needed.
Demographics show numbers needing care set to soar: The cohort needing care at the moment is a relatively small proportion of the population, but millions of baby boomers are currently reaching their 60s and will need care in the coming twenty years or so. The numbers needing care are, therefore, set to soar.
Long-term care funding is one of the least understood parts of the health and care system. Unfortunately, many people mistakenly believe the Government will pay their care costs. But social care is the responsibility of local authorities, not the free NHS. This system dates back to the Poor Laws of the 1800s and was completely omitted when Beveridge developed our National Insurance system and welfare state. The difference between social care and healthcare is not easy to define, but as an example, someone with cancer is likely to qualify for healthcare funding with care provided at taxpayers’ expense, while someone with dementia may not be considered to have a ‘health’ need and gets no public money at all.
Public need to be informed about preparing for care: We could extend the PensionWise Guidance service to provide information and education for people about preparing for care needs. This could come from their pension savings or additional savings but because people don’t understand the system, they will definitely need help in planning for care.
The time to address this crisis is now: It cannot wait longer without causing more misery. Social care in this country is failing and radical action is long overdue. This is not just about elderly people, it’s about families and loved ones who are being denied a decent standard of living in modern-day Britain. Introducing incentives to help people save for later life care, as well as earmarking more funds from council and healthcare budgets, in an integrated fashion, will be vital parts of any solution.
December 14, 2016 1 Comment
23 November 2016
- Autumn Statement is missed opportunity to address social care crisis
- State Pension triple lock seems under threat
- Chancellor confirms intention to ban pension cold calling
The Chancellor’s Autumn Statement had no real surprises for pensions or savers. There are some tweaks to pension rules, but the biggest disappointment for me is that there is no acknowledgement of the social care crisis. The Chancellor started by saying the aim of his budget is to prepare and support the economy for a new Chapter. Part of this new chapter includes the aging of our population. This is a huge social issue as baby boomers reach their 60s and are heading for longer lives than previous generations.
I’m delighted to see a greater sense of urgency for new infrastructure and housing investment, this is vital for the future success of our economy. I hope that our own long-term domestic investment funds – in particular pension funds and insurance assets – will be brought into Government to ensure they can participate in such investments. However, it is really disappointing that there were no new savings incentives to help families set money aside for social care and not enough extra public funding to ensure decent care can be delivered to those elderly people who are currently denied the help they need.
Here is a summary of the measures and my thoughts:
- Chancellor has not recognised the scale of the challenge the country faces in social care
The Chancellor has missed an opportunity to really signal that the Government cares about the social care crisis. The country has no money set aside for elderly care – families do not even know that the NHS cannot be relied on to provide care. The NHS will step in under some circumstances, but most families will find that they have to fund care themselves. If they don’t have any savings, then they will be at the mercy of cash-strapped councils who are cutting back care provision and provide only a bare minimum. New savings incentives for social care are needed urgently, not just to ensure at least some families will save for care, but also to help people realise that they need to think about this. The NHS does not and cannot look after increasing numbers of older people from cradle to grave. In an aging population where it is estimated that over 1million older people who need care now are not getting it. Without more funding this can’t be delivered. Allowing councils to raise an extra £2billion in council tax for care by 2020 is simply not enough. The needs are higher than that already and the problem is only getting worse. Employers could be incentivised to help workers with care savings plans, perhaps with elderly care vouchers but currently there is no help at all for employers or employees to provide for future care needs. This will have spillover effects on our precious NHS, because we can’t cut social care without hitting NHS. So taxpayers will keep having to put more money into the NHS if there is not extra funding for social care.
- Good news for pensions – Government will consult on banning pension cold calling and further measures to crack down on pension scams
It is great to see that the Chancellor has confirmed he will consult on banning all cold calling for pensions and also look for other ways to clamp down on pension scams and frauds. This is most welcome. By making pension cold calling illegal, it will be much easier to help people understand that those who do contact them out of the blue about their pensions are acting against the law. We must do as much as we possibly can to protect people’s precious pension savings.
- Triple lock looks under threat beyond 2020 – watch out for more developments
The Chancellor’s speech signalled pretty clearly that the State Pension triple lock is only safe until 2020. He talked about the need to adjust to rising longevity and alluded to a review of State Pension uprating. Currently, the law only requires Basic State Pensions and new State Pension to be uprated in line with earnings after 2020. I would like to see a double lock announced, whereby State Pensions would rise in line with either earnings or prices. Currently, the Additional State Pensions only rise in line with prices. Perhaps the Government could consider increasing all aspects of state pensions in line with a double lock to simplify the system.
- Reduced Money Purchase Annual Allowance cut from £10,000 to £4000. Why not to £3,600?
The Chancellor will reduce the amount of new money someone over age 55 can contribute to a pension after they have already taken some money out of past pension savings. Currently, those who have already taken money out of their pensions under so-called ‘flexible access’, can put a further £10,000 a year into new pension savings and get tax relief on that. The Chancellor plans to reduce that to £4,000 a year instead. This will raise revenue for the Treasury, but it does seem a shame that he did not decide to just reduce the new MPAA to £3,600 a year, which would align it with the maximum amount that non-taxpayers are allowed to pay into a pension with a 25% bonus of basic rate tax relief being added.
- Encourage British pension funds and insurers to invest in infrastructure and social housing
The Chancellor has announced that it will extend the UK Guarantees Scheme for infrastructure bonds and loans and that it is working with ‘industry’ on construction-only guarantees. I do hope the new Ministerial group on delivery of infrastructure projects will work closely with UK pension funds and insurers so that British people’s pensions and long-term savings can help fund long-term improvements in the British economy
Good news for savers:
- A new 3-year NS&I savings bond with market-beating interest rate of 2.2% from next Spring
It is really important to encourage more people to save and these bonds will be of some help to savers who have lost out from Bank of England’s policies. The Chancellor plans to bring back the special savings bonds that were offered to the over 65s before the 2015 General Election. This will allow anyone over age 16 to put up to £3000 into a new National Savings and Investment product that will pay 2.2% interest. It will be available for 12 months from next Spring. This will help some savers who have suffered so much for exceptionally low interest rates. There are already tax breaks for savers, who can earn up to £5,000 a year in savings income tax free but the interest rates on savings accounts have fallen so low that savers need more help.
November 23, 2016 No Comments
19 November 2016
- Treasury set to ban pension cold calling in Autumn Statement
- Well done Philip Hammond – this is a great start to help clamp down on scams
- Clear signal for people that such calls are illegal so they should Just Hang Up or delete email
- Further measures to stop scam schemes setting up and clamp down on transfers also welcome
- We must do all we can to protect people’s precious pension savings and this is a positive step
The Chancellor is going to announce that pension cold calling is to be made illegal. He may also be announcing additional measures to help protect customers, by making it harder to set up scam schemes and to transfer money into them.
Well done Philip Hammond – we have to do whatever we can to protect the public against fraudsters. Vulnerable elderly people are being called and offered free ‘pension reviews’ which lead to them losing their entire life savings. We need to be able to give the clear message that if someone contacts you out of the blue about your pension, they are breaking the law, they are criminals. By making cold calling illegal, it is much clearer for the public that they just should not engage with such people.
So far, the government has tried a number of initiatives, such as Project Bloom, Project Scorpion, Action Fraud and cross-Departmental taskforces that aimed to warn the public and catch the fraudsters. Unfortunately, the Government admitted in response to Written Parliamentary Questions that nobody has been convicted and only a handful have even been charged. The current indirect approaches are very well-meaning, but just don’t work for the people who need protecting.
A ban on cold calling is obviously not going to stop all scams, but it gives people a fighting chance of recognising the dangers before they engage and also ensures that we can give the public the clear message that such approaches are dangerous and should be avoided at all costs.
Ideally we would want to find ways to stop pension firms transferring people’s pensions into scam schemes, however that is far more difficult. A ban on cold-calling is something that can be done more quickly.
I worked hard as Minister to try to achieve this and am delighted to see it looks as if this will finally happen. Officials and other Ministers tried to caution against banning cold calls because they did not want to stop bona fide businesses being able to contact customers. That argument is false. No bona fide company should contact people out of the blue offering free pension reviews or investment schemes for their pension savings. If a firm wants to generate new customers, they will have to find better ways than just buying up lists of contact details and cold calling people.
A number of advisers have set up a petition which has helped to focus attention on this issue and the media has been great in supporting the ban on cold-calling.
A victory for common sense and for customer protection. Well done to all.
November 19, 2016 1 Comment
14 November 2016
LIFETIME ISA TO BE NEXT BIG MIS-SELLING SCANDAL – CHANCELLOR MUST THINK AGAIN
- Providers beware – don’t sell this product carelessly, it could come back to bite you!
- FCA rules should require advice, suitability checks and risk warnings before providers sell this
- Pensions are best for retirement saving – right behavioural incentives to keep money for old age
- Lifetime ISA could snatch defeat from the jaws of victory as pension coverage rises
- Lifetime ISA won’t last a lifetime – and may confuse younger people into opting out of pensions
- Greater risk of later life poverty for today’s younger generations who spend all LISA at 60
I am calling on the providers to wake up to the risks of selling Lifetime ISAs to people who would be much better off using pensions for their retirement savings. I hope that the Chancellor will recognise these risks and make changes in the Autumn Statement. We should not confuse people about the best way to save for retirement – pensions are unquestionably the best for the vast majority of people. If the Treasury does not understand the risks, then I hope the FCA will clamp down on how these products are sold, to make sure there must be careful suitability checks and risk warnings before people lock money into the LISA, thinking this is an appropriate way to save for retirement.
I list here twelve reasons why Lifetime ISAs are a bad idea for retirement saving
- LISAs likely to be new mis-selling scandal waiting to happen – not simple products, need proper risk warnings and suitability checks: LISA must not be sold carelessly. The FCA and providers should recognise need for proper risk warnings and adequate suitability checks. Without proper safeguards for consumers, this is a major new mis-selling scandal waiting to happen, when workers wake up to the fact that they are much worse off than they would have been in a workplace pension scheme. Will they complain to their provider or their employer? We don’t know, but it is clear that those who opt out of workplace pensions, or give up an employer pension contribution or lose out on higher rate tax relief will be worse off with a LISA than a pension. Even those who don’t give up an employer contribution could be worse off. If this product is sold carelessly and they don’t realise this, they will have valid reasons to complain in coming years.
- People likely to have less money in retirement as a result of the Lifetime ISA: LISA will see lower contributions going in, lower investment returns, some withdrawals along the way. The amounts of money going into LISA will be lower than if workers put the same amount into a pension. This is because at best they only get the equivalent of basic rate tax relief, they will not have an employer contribution, they will lose any National Insurance relief or higher rate tax relief they could get on pension contributions, more is likely to be saved in cash giving lower long-term returns, charges may be higher than pensions as there are no controls on the Lifetime ISA charges and they may spend the whole lot at age 60.
- Snatching defeat from jaws of victory as Lifetime ISAs will confuse workers about how best to save for retirement: As auto-enrolment is bringing millions more people into pension saving, and opt out rates are low, it is clear that workers have welcomed being put into pensions by their employer. This is a real success story, but we may be about to snatch defeat from the jaws of pensions victory. If people hear about Lifetime ISAs and don’t understand the benefits of pensions, they may be tempted into opting out of a workplace pension and using a LISA instead. This will leave workers worse off in later life and at much greater risk of poverty in old age than if they saved in a pension.
- Lifetime ISAs will not last a Lifetime – behavioural incentive is to spend all money at age 60: The LISA has major incentive to spend the entire pot around age 60, which means having nothing left in your 80s. This is not a sensible retirement saving structure! The point of retirement saving is surely to make sure future pensioners in decades to come will have money to live on, in excess of just state benefits, when they reach much later life. A pension incentivises people not to spend the money too soon, since pension freedoms mean they will pay large amounts of tax if they take too much out, whereas it can pass on tax free now that the 55% death tax charge has been abolished. Incentivising spending the money too soon is classic irresponsible pension policymaking, leaving future Governments to clear up mess created by today’s policies.
- Lifetime ISAs cost today’s taxpayers billions of pounds while still leaving a future Government to deal with millions of poor pensioners who spent it all too soon: Today’s taxpayer subsidy is forecast to cost billions of pounds, but this public money will be wasted if future 60-somethings just spend the whole lot as soon as they can because it’s tax free and because they fear a future Government will tax the money. Giving taxpayer help for house purchase is fine, but let’s focus the retirement saving help on pensions, rather than confusing people with a new inferior product.
- Less money will go into LISAs than pensions: Upfront tax incentives for LISA are no better, and will generally be much worse than for pensions. Partly because the 25% is only the same as basic rate tax relief, partly because there is no employer contribution, partly because people will lose any National Insurance relief and of course people may not trust a future Government to keep the money tax free and therefore contribute less.
- Less money will build up over time than with pensions: Lifetime ISAs will see less money building up in long-term savings than would be the case with pensions. This is because there is no employer contribution, there is no higher rate relief (the 25% is the same as basic rate relief which is the minimum available to pension savers), partly because more will be held in cash and partly because some people will have taken money out along the way.
- 5% penalty on Lifetime ISA withdrawals will drain people’s resources: The 5% penalty on withdrawals is draconian – especially as we are about to cap exit penalties on pensions at 1%! We have seen with 401Ks that many people simply take money out because they can and therefore less is left for later life. A retirement saving product is best left alone till retirement, and ideally needs to last until your 80s or 90s. Pensions are far better for this than ISAs.
- Pensions are more likely to last a lifetime than Lifetime ISAs. With no inheritance tax to pay on money passed on from the pension, and no 55% death tax charge, it is safe to keep the money for later life. However, with an ISA, people will want to spend the money sooner while it is tax-free and there is no ‘brake’ on spending it too quickly.
- Lifetime ISA could help first time buyers, but we already have HelpToBuy ISA so why confuse ISAs with another product? Those saving to buy their first home can benefit from using a LISA, but there is already a Help To Buy ISA for that purpose. We do not need to confuse the ISA brand with yet another product – it is better for people to keep this simple and separate.
- Lifetime ISA will be great for wealthy people – but are they the ones who need further taxpayer subsidy?: Many people wanting to buy Lifetime ISAs will already have filled their full £40,000 annual allowance, or Lifetime Allowance. Some IFAs have wealthy clients who are eager to take advantage of the generous taxpayer subsidies as another tax-incentivised savings vehicle for their children or grandchildren. But is this a sensible use of taxpayer subsidy? Those who most need retirement savings will normally be better off using pensions – do not need another product to confuse people, or cost more taxpayer resource.
- Most ISAs are held in cash with lower long-term returns but no controls on charges: Cash savings can be fine if you’re saving for a house or other defined nearer term goal, but for retirement saving the best investments are longer-term investments that have better growth potential and should give more money for pensions in later life. People may end up with relatively high charges for this complicated product while saving in cash.
November 14, 2016 1 Comment
13 September 2016
- Time for a proper national debate about the impacts of Monetary Policy
- Government should launch an inquiry into the effects of lower interest rates
- QE was an emergency policy to stave off depression – it is a huge monetary experiment which must not be considered as ‘normal’ policymaking
- The latest round of rate cuts and QE may well have been a mistake – in August 2016 we were not facing economic collapse and the negative side-effects need to be considered
- Monetary policy may not be working as theory predicts as banks have failed to pass on lower rates to many borrowers, while savings rates have fallen sharply
- Credit card, overdraft and even SVR mortgage rates have RISEN over the past 5 years
- Lower rates and QE are supposed to be expansionary but also have deflationary effects as they reduce disposable incomes for both households and some corporates
- QE has damaged UK Defined Benefit pension schemes and placed higher costs on firms
- QE has increased annuity costs significantly which also damages Defined Contribution pension income
- Distributional effects of QE may have political implications as ordinary savers and renters suffer while QE helps the wealthiest, perhaps feeding public dissatisfaction
This paper presents an alternative view of monetary policy to that which has been used by the authorities. I suggest that monetary measures have impacts that are rather like a tightening of fiscal policy, which may offset the expected expansionary effects. I hope you will find this of interest and that it may stimulate more detailed debate of the real impacts of the unprecedented policy experiment which is underway. The Bank of England believes its latest rate cuts and QE expansion will boost growth. The Governor says he is serene about its policies. However, the full impact of the QE experiment will not be known or understood for many years, while its negative side-effects may have been underestimated.
No economic emergency: QE was originally introduced as an emergency measure to boost growth and stave off economic collapse. However, with record employment levels and no recession (let alone depression as was feared a few years ago) it is hard to argue that interest rates in August 2016 were ‘too high’ or were stifling spending and investment. Indeed, economic indicators have recovered somewhat, the economy is certainly not facing imminent collapse, so aggressively pushing rates lower from already exceptional levels may not be an appropriate policy.
QE is not normal: It is worrying that this massive monetary experiment of printing money to artificially distort long-term interest rates may now be considered ‘normal’ – it is certainly not normal at all. Indeed its effectiveness is unclear. It may do more harm than good and if any post-Brexit economic weakness is structural, rather than cyclical, monetary easing is unlikely to help.
The combined impact of low interest rates and more QE reduces the disposable incomes of savers and pensioners. In some respects, monetary policy is acting like a tax increase, so attempts to ‘ease’ monetary policy have effects that resemble a tightening of fiscal policy. Soaring house prices and rising rents have reduced younger people’s spending power, while savings and pension income for older groups have been cut. In an aging population, the expected income, substitution and wealth effects may fail to work as theory predicts. The table below is a quick summary of the relative balance of impacts. The net effect of the Bank of England’s policies depend on the strength of each of these effects.
|Reflationary impacts expected by Bank of England||Deflationary effects that may offset expected expansionary impacts|
|As interest rates fall, net savings fall and savers are expected to spend more||Lower savings income may lead savers to spend less|
|As borrowing costs fall, corporate borrowing for capital investment is expected to increase||QE increases pension deficits, so higher company pension contributions may lower corporate investment|
|Lower borrowing costs for households are expected to help them afford to spend more||Lower pension income may mean less spending as annuity income falls for new pensioners|
|As QE increases asset prices (e.g. house prices), a wealth effect is expected to boost spending as asset owners feel wealthier||Higher rental costs as house prices rise may reduce spending and higher house prices may lead to higher savings to afford to buy homes|
|Income effects of lower rates for both savers and borrowers are expected to reduce saving and increase spending||As savings income falls, savers may actually spend less or save more to afford housing|
|A Substitution effect is expected as rates fall and households or corporates are expected to bring forward spending plans which will boost growth||Households and corporates may believe QE and falling rates signal economic problems ahead and reduce spending. There are also concerns that continually bringing forward future growth cannot continue indefinitely|
The monetary policy transmission mechanism is not working as theory predicts: Let’s look at the impact of the Bank of England’s policies. The first part is the fall in short-term interest rates as bank rate has fallen closer to zero. The second policy element is the Bank’s Quantitative Easing programme designed to lower long-term interest rates too.
- Lower short-term interest rates
Low short-term interest rates are meant to boost household spending: Households are expected to increase their borrowing as loans become cheaper and savers are supposed to reduce net saving as their income falls. In fact, the pass-through of low short rates has been weak, as banks have not reduced borrowing rates much, if at all, but have lowered savings rates more significantly. In an aging population, savers facing falling income may not just increase their spending. They may look for better returns on their savings, or even save more for the future.
Though short rates have been near zero for years, many household borrowing rates have actually risen: Over the last five years, credit card interest rates and bank overdraft rates have actually increased, despite low base rate. Indeed, credit card rates and overdraft rates are 2% higher than they were in August 2007. Clearly, banks have not been passing on the benefit of low interest rates to these borrowers. Therefore, low rates will have less impact than theory predicts.
Even mortgage rates have failed to properly reflect the base rate cuts: In August 2016, average 2-year fixed rate mortgages had an interest rate 1.17% lower than five years ago. However, rates for an average Standard Variable Rate mortgage were higher than in August 2011. Lenders are also charging households higher fees and imposing tougher conditions on loans. Therefore, ordinary households have not really felt as much benefit from the ultra-low interest rate environment as might be expected. And even though fixed rate mortgage costs have fallen, the rise in house prices means the size of a mortgage required for house purchase has increased. For many people the costs are so high relative to their income that they cannot get a mortgage at all.
MANY BORROWING INTEREST RATES HAVE RISEN, NOT FALLEN
|Date||Credit Card %
|Standard Variable Rate Mortgage %||2-year fixed
75% LTV %
|Interest rate change over past 5 years||+1.23%||+0.3%||+0.22%||-1.17%|
Source: Bank of England
Of course, over the past five years, savers’ interest rates have fallen sharply: While the above table shows the low interest rate environment has not fully fed through to borrowing costs, the average interest rates for savers have fallen quite significantly over the past five years. Banks do not need savers’ deposits as the Bank of England gives them plenty of cheap funding, while the latest Term Funding Scheme helps further. . Thus, interest rates on Cash ISAs, fixed rate ISAs and fixed savings deposits were significantly lower in August 2016 than five years ago. Banks have cut saving rates by more than the base rate fall and cut borrowing rates by less, to boost margins
SAVERS’ INTEREST RATES HAVE FALLEN SHARPLY
|Date||Cash ISA||1 yr fixed ISA||2 yr fixed Deposit rates|
|Int. rate change||-1.77%||-1.6%||-2.06%|
Source: Bank of England
- Quantitative Easing
The second part of the Bank of England’s policy has been forcing long-term interest rates down, by creating billions of pounds of new money to buy gilts. Buying more gilts forces up gilt prices which means lower yields, but also artificially distorts these supposedly ‘risk-free’ assets.
Bank of England suggests QE protects the value of savings and wealth, but higher asset prices are irrelevant to cash savers: The Bank of England claims QE has boosted the value of financial asset holdings and that this ”protects the value of savings and wealth”. However, asset prices are irrelevant to cash savers. Most people’s savings are in deposits of less than 2 years’ maturity, so they do not benefit from increases in asset prices resulting from QE. The majority of households hold their savings in bank or building society accounts, ISAs and National Savings which have been damaged by the low base rate policy and have not necessarily benefited from QE.
QE has distributional impacts as rising asset prices helps the wealthiest: The Bank of England admitted in 2012 that ”those households with significant asset holdings will benefit by more than those without”. It said it had boosted the value of stocks and bonds by £600bn and that this is ‘equivalent to £10,000 per person if assets were evenly distributed across the population’. But assets are not evenly distributed so gains have gone largely to the wealthiest 5% of households. Further QE merely magnifies those effects. The Chart below shows the Bank of England’s 2012 estimates of the redistribution of wealth resulting from QE. The ongoing and further rounds of QE exacerbate this redistribution of wealth, with the wealthiest households becoming even wealthier.
QE has deflationary effects which may undermine its effectiveness: QE is designed as an expansionary policy, but some of its effects are similar to a tightening of fiscal policy. There are several ways in which QE has deflationary side effects.
High house prices can be deflationary: The Bank of England has suggested that its policies have supported house prices and that this benefits the economy. However, artificially boosting house prices is not necessarily reflationary. The wealth effect of high house prices may not be strong enough to offset the income effects of falling disposable incomes for renters or those saving more to try to get on the housing ladder. Housing wealth is not evenly distributed, with significant regional, demographic and income disparities. The high cost of housing relative to salaries prevents younger generations getting on the housing ladder and forces up rental costs. Rather than supporting house prices, policy needs to address the shortage of housing by building more homes.
Lower gilt yields damage UK Defined Benefit pensions: The Bank has underestimated the dangers of low gilt yields for company-sponsored pension schemes. Artificially depressing long-term interest rates increases pension deficits and imposes extra costs on companies sponsoring pension schemes. Deficits have soared to nearly £1trillion on some estimates. All measures show rising deficits for UK pension schemes following the latest gilt yield falls. The Bank of England itself is insulated from the effects, because its own scheme has ‘employer’ contributions of over 50% of salary which are funded by levypayers. Private sector firms are struggling to meet these costs and addressing their ballooning pension deficits will weaken their business. As firms put more money into their pension schemes, they have less money to spend on expansion and job creation. For example, Carclo had to withdraw its planned dividend payment in order as a result of its pension deficit. Pension funds are becoming locked in a vicious circle. The more the Bank of England buys gilts for QE, the more expensive – and unaffordable – it becomes for trustees to buy assets to try to reduce risk. If they compete with the Bank of England to buy more gilts, they drive gilt prices up more, which increases their deficits even further. For many schemes, this can be a ‘death spiral’. Some firms have been bankrupted as a result of their pension problems. QE makes Defined Benefit scheme funding seem like a bottomless pit. The Bank’s insouciance on pension issues is troubling.
QE has driven up the cost of buying annuities but Bank of England has ignored this effect: The impact of QE on annuity rates has not been investigated. This may be a serious omission. Rising annuity costs have potentially serious implications. QE has forced up the costs of buying bulk annuities, making it too expensive for companies to remove defined benefit pension liabilities from their balance sheets.
QE has damaged Defined Contribution Pension savers too: In addition to the problems created by increasing annuity costs for employers running Defined Benefit schemes, annuity problems can affect ordinary households too. Retirees buying an annuity will have lower incomes for life as a result of QE and will never be able to recover their losses. In 2012, the Bank of England claimed: ”QE has raised the value of pension fund assets too. Once allowance is made for that, QE is estimated to have had a broadly neutral impact on the value of the annuity income.” This conclusion is flawed. Most ordinary investors’ Defined Contribution pension savings are invested in with-profits or insurance funds which have not performed well enough to offset annuity falls resulting from QE.
QE artificially distorts asset markets – nobody knows what this means: Gilts are supposed to be ‘risk-free’ assets, but by artificially boosting gilt demand, the Bank of England has distorted gilt prices. Thus, QE has added risk to gilts, potentially creating an asset bubble in the very market that is supposed to be risk-free and on which other asset valuations are based. This adds risk to all financial assets and nobody knows what the medium term impacts will be. Printing new money and debasing a currency may be politically expedient short-term political palliatives, but will usually fail to solve underlying problems and generally have damaging long-term consequences.
In summary, monetary policy may not work as the Bank of England’s theoretical models predict: This paper suggests that the current stance of monetary policy and the most recent policy decisions may not work as intended and have damaging side-effects that could even offset any expected stimulus. So what other measures might Government consider for boosting growth, with less damaging side-effects?
As QE operates indirectly and its transmission mechanism may not work, direct stimulus might be more effective: QE creates new money which is intended to find its way into the real economy to boost growth. However, the transmission mechanism is indirect and the Bank of England cannot ensure that this newly created money does go where it is needed in order to create growth and jobs. There may be better policies to pursue, for example:
- Temporary tax breaks for capital projects: Introduce temporary tax breaks for capital spending to encourage companies to bring forward investment plans. The biggest benefit of QE is that it has allowed companies to borrow more cheaply and large firms are flush with cash. However, they are not spending it, so an incentive to invest could help economic activity.
- Boost construction: Introduce incentives for new housebuilding or construction
- Use pension assets to build new housing: The UK has billions of pounds in pension assets which could be used to build new housing, rather than trying to invest in gilts. This can help to deliver better returns as well as overcoming the UK housing shortage.
- Use pension assets to invest directly in infrastructure with Government underpin: Using the billions of pounds of pension assets to bypass banks and invest in infrastructure or even lend directly to small firms would offer more direct stimulus. It may require a Government to guarantee that the pension assets will receive at least a gilt yield return over, say, 1 years, if the project does not return more than the yield on 10 year gilts. This would mitigate some of the risk for the pension scheme and allow pension funds to use these potentially higher return assets in the liability-matching portion of their asset allocation, while hoping to benefit from higher returns as well.
- Consider ‘helicopter’ tactics: It might be more effective if the Bank had sent a “time limited” cheque to all households, rather than letting low interest rates continue to squeeze people’s income. This would encourage spending directly. The Bank of England rules this out, but it is possible that it would be more expansionary than QE. In fact, the £25billion paid directly to households since 2011, in the form of PPI compensation, may have boosted growth more than the low base rate and gilt-buying program.
Conclusion: QE, coupled with ultra-low rates, is supposed to be expansionary, but some of its effects are deflationary. It is not yet clear whether the expected expansionary impacts are being more than offset by the contractionary side-effects. Indeed, if any economic weakness following Brexit is structural, rather than cyclical, then monetary policy will not work as expected. In some ways, QE and the base rate cuts have acted rather like a tax increase. They have reduced current and prospective disposable incomes. Savings income, annuity income and prospective pension income are all lower as a result of the Bank of England’s policies. Monetary Policy can buy time for Government to introduce new demand-stimulus measures, supply-side reforms and reducing fiscal imbalances. But, without other measures, buying gilts is unlikely to generate growth.
And finally, some politics…The Bank of England’s policies have distributional effects and the Government has perhaps not sufficiently recognized this. The following table summarises which groups have largely benefitted from monetary policy moves and which groups are damaged by it, with the wealthiest gaining while ordinary savers, renters and younger households lose out. Might it be possible that monetary policy could have contributed to the dissatisfaction among voters who feel left behind in recent years. The rise of anti-establishment nationalist movements, epitomized by the Brexit result, may reflect anger at the financial difficulties facing some parts of the population, which policymakers have failed to recognize. Politicians might like to consider how this balance of winners and losers fits with a desire to help the many, rather than the privileged few.
Groups benefiting from monetary policy
Groups damaged by monetary policy
Wealthiest asset owners
People trying to buy a home
People renting a home
Savers relying on interest income
Pensioners buying annuities
Borrowers with large tracker mortgages
Companies with defined benefit schemes
Gilt traders or market makers
|Pension scheme members whose schemes failed due to QE impact on deficits|
September 13, 2016 3 Comments
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