Category — Savers and Savings Policy
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
9 August 2016
- Monetary policy is not helping ordinary people and low rates may be doing more harm than good
- Ordinary savers are being hung out to dry and pension problems have worsened
- Government should issue more high interest 65+ guaranteed growth bonds – but for all age groups
The latest decision by the Bank of England to cut base rate from 0.5% to 0.25%, as well as expanding Quantitative Easing by £60billion, is supposedly designed to boost the economy. But millions of savers and pensioners are suffering serious potential income shortfalls as a result of this policy.
I believe the damaging side-effects of low interest rates have been under-estimated. Not only are significant sections of the population being hit near-term, the consequences for the medium and longer term are also negative.
Bring back special savers’ bonds: As the banks no longer want or need ordinary savers’ money, the Government could offer better interest rates directly. Bringing back the special savings bonds that were issued from January to May 2015 for the over 65s, but this time for all age groups, would prove popular. They had market-beating interest rates of 2.5% or 4% and were the most successful financial product for years. A new issue of such bonds, but not just limited to older savers would reward savers for setting money aside. This is vital if we are to sustain a savings culture in this country. Until a few weeks ago, the Bank of England had been suggesting the next move in rates would be upwards – signalling some relief for savers after years of misery. Now that rates have fallen even further instead, the authorities need to consider the impact on prudent people who want to provide for their own future. The Government also needs to consider how to help companies that are struggling with rising pension deficits. Issuing special bonds for pension funds, offering to underpin investments in infrastructure and housing, would be direct ways of helping alleviate the damage of monetary measures. The Government needs to find ways to offset the negative side-effects of the Bank of England’s latest moves.
What is the damage to savers? With interest rates staying so low for so long, and rates continually falling further, savings incentives and savers’ incomes across the economy are being destroyed. This has two damaging consequences which could actually weaken economic growth.
Lower savings income means savers save less and spend less: Firstly, many people who have saved over the years for their future are facing further income falls. This may cause them to cut spending, especially if they are in retirement and cannot see a way for their income to increase in future. Indeed, many savings account interest rates are being reduced by more than the 0.25% rate cut. Banks and building societies do not need to attract savers now, as the Bank of England’s decision to introduce its new Term Funding Scheme gives the banks cheap money directly from the Bank of England instead.
Destroying saving incentives for younger generations: Secondly, many people are deciding it is not worth bothering to save as the returns are so tiny. People who might have saved but decide not to bother will be poorer in future. Young people are losing the savings culture that the current older generations often grew up with. Modern societies still need savers, especially as life expectancy increases and the population is aging rapidly. This lack of savings, and potentially higher borrowing risks damaging growth in future.
What is the damage to pensions? Again there are two damaging consequences for pensions, both of which are likely to weaken growth.
Rising annuity costs means less pension for life: Firstly, as interest rates are pushed lower, the costs of buying an annuity have soared. People looking to lock into a guaranteed lifetime income will be offered much less pension than ever before. Even if the value of their pension fund has increase a bit, the cost of annuities has usually risen by much more. And, of course, once they lock into an annuity for life their income will never recover, even if rates rise in future. So pensioners will have less money to spend, which is hardly an expansionary policy.
Pension deficits weaken company growth prospects and reduce pension contributions for younger workers: Secondly, employers who are running final salary-type Defined Benefit pension schemes are facing much higher deficits as a result of the expansion of QE. As gilt yields fall further, employer pension liabilities have soared. Just today, the Pension Protection Fund PPF7800 index announced that its measure of pension deficits rose last month to around £400billion. It will rise further this month as a result of the extra QE. This will weaken the employers sponsoring such pension schemes, damaging their business prospects, potentially preventing them from investing or borrowing to fund growth and sapping corporate resources away from both their business and employment expansion. As most private sector final salary-type schemes are now closed, the rising deficits are likely to mean employers have less money to spend on providing good pension contributions for those workers who do not belong to these schemes, – usually younger employees.
Monetary policy is too focussed on financial institutions and borrowing: Monetary policy seems to be overlooking the negative consequences on households (and parts of the corporate sector).
Low rates do not necessarily help mortgage holders and QE has led to rising rental costs: Typically, if short-term interest rates fall, borrowers’ incomes increase, and they are expected to spend more (or even borrow more to finance extra spending). However, falling base rates may not help borrowers as much as expected. Mortgage payments are a major element of household borrowing, but around half of mortgages are on fixed rates, so they do not benefit from the base rate cut to 0.25%. Indeed, the other element of monetary policy – QE – has damaged especially younger people because it has caused rising property prices. Ordinary people have to either take out a much larger mortgage to get on the housing ladder, or must pay much more in rent. So monetary policy has made them worse off.
The Government could help offset damaging impacts of monetary measures: Because these changes in Bank of England policy have many potentially harmful side-effects, the latest loosening of monetary policy may need to be offset by fiscal measures. Certainly, the transmission mechanisms of lower interest rates are very indirect – relying on sellers of bonds to boost asset prices or stimulate extra borrowing. More direct help is likely to have a better outcome. The indirect stimulus cannot be relied upon to prevent an economic slowdown, while direct measures to increase household incomes and spending, as well as helping offset the effects of rising pension deficits, will be more beneficial to the British people.
August 9, 2016 1 Comment
19 April 2015
- Review of financial fairness and extending financial guidance to younger savers
- Minister for financial consumer protection and financial education
For so many years I have been an independent consumer champion, working on making finance work better for customers, exposing injustice and helping ordinary savers understand finance. I have focused on policy, rather than politics, trying to make finance work well for the many, not just the few. I have worked with all the major political parties and have maintained my neutrality but I want to let you know that I have now decided that the best way to achieve what customers need is to become more directly involved.
The following is from the Prime Minister’s official release:
“Ros Altmann to be a Minister in the next Conservative government – leading a review of financial consumer protection and financial education
Today the Prime Minister is announcing that consumer champion and pensions expert Dr. Ros Altmann is to be nominated as a Conservative peer and will be appointed as a Minister with responsibility for financial consumer protection and financial education in a Conservative government.
Improving dignity and security in retirement for working people lies at the heart of the Conservatives’ long-term economic plan.
Following the biggest pension reforms in a generation, one of her first roles will be to lead a review of financial fairness for consumers.
The Prime Minister said:
“What we’re doing is taking the country’s leading expert on pensions, on savings, on financial education, Ros Altmann, and saying that if we’re re-elected, she’ll be at the heart of government, making sure we complete this great revolution where we’re giving people much more power to save, to access their pension, to pass their pension on to their children, because we want to create a real savings culture in our country for everybody. Not for the rich at the top, but for everybody who saves or has a pension.”
So, I will have the chance to work from inside Government, in a Ministerial role that will straddle both the Treasury and the DWP, on consumer protection, financial fairness and financial education. I believe that working in both Departments is important in order to have joined-up policy.
Following on from the pensions and savings reforms introduced in the past year, it is so important to ensure that customers are treated fairly by the large financial companies. I also believe it is vital to roll out financial education to everyone, not just those nearing the end of their working life.
I will carry out a major review of financial fairness for consumers, including:
- charge caps for pension products to protect savers from excessive fees;
- improved rights for older consumers especially in the mortgage market;
- promoting competition and innovation for all savers;
- developing the Pension Wise service to offer financial education and guidance to working people at every stage of their lives – not just nearer retirement
I do passionately believe the new pension reforms – and trusting people with their own money – are an essential step to helping everyone make the most of their hard-earned savings. For too many years, consumer rights have played second fiddle to the interests of large financial firms, but the new pension freedoms show that the Conservatives have put the interests of British savers first and that is a real game-changer.
In the 2014 Budget, they stood up to the large companies who had too often taken advantage of their customers and have paved the way for a new environment for long-term savings, which does not force people into buying products that may not be suitable for their needs. They have created the opportunity for working families to save more if and when they can, knowing they will be allowed to use the money as best fits their circumstances.
There are some who say only the financial industry, or Government, know best what people should do with their money and that most people can’t make sensible decisions for themselves. Well, I disagree. Yes, some may be reckless but I truly believe most British savers will be responsible and can be trusted to make the right choices. They will need protection, they will need guidance and many will also need advice, but that is where I hope I can make a difference.
It will be my job to review this and ensure customers get a fair deal – I am delighted to be offered the chance to do so.
I want to see long-term savings work better for ordinary families who put their hard-earned savings aside for their future, which is so important to restoring the strong British savings culture. Those with the largest pension savings already had the freedoms and flexibility that are now open to everyone, but of course we must ensure financial services firms move with the times. This will mean a new mindset from providers and potentially further Government action to protect savers better.
Of course it won’t be easy, but I’m determined to make a difference. I will remain a champion for consumers, but also want to work with the industry to adapt to the new environment. I can do this far more effectively from within Government than as an independent outsider.
I will also continue to champion the need for fairness and inclusiveness for women and for customers of all ages – which is where I believe financial education and guidance can be particularly powerful.
The savings and pension reforms are only a start, the next steps are yet to come. Making financial services work better for the customers they are trying to serve will ultimately also benefit the industry itself. We have strong, vibrant financial firms who are world leaders, but their long-term success will require a new approach. Modernising and adapting are vital. Some are already recognising this and I look forward to engaging constructively with them. Too many, however, are still relying on past captive customers being locked into expensive, inflexible products. Such practices need to be abandoned, in favour of more customer-friendly approaches, that will bring far more money into long-term savings in future.
I hope to help this happen.
April 19, 2015 1 Comment
18 March 2015
We had the Pensions Revolution last year, now comes the Savings Revolution
- 95% of savers will pay no tax on their savings – will be popular
- 5m will be allowed to sell their annuity – that’s great news
- But cutting Lifetime Allowance for pensions is really bad policy
- Lifetime limit should only apply to DB, but abolished for DC
So there we have it. The last Budget before the General Election. A mix of moves to please as many of the electorate as possible, but without committing massive amounts of extra spending. There is help for savers, help for first-time housebuyers, but nothing to help with the social care crisis.
The main news this time is the help for savers. This is unquestionably good news for ordinary savers with 17million people benefiting from the decision to scrap basic rate tax on the first £1000 of savings income each year. This will be popular, as 95% of savers will not pay any tax on their savings income. Savers have paid tax on their income when they earned the money, so allowing them to earn interest on it free of tax makes sense.
What might this mean for savers?
People with £50,000 savings may not pay any income tax on their savings: If we assume savers earn 2% interest on their money, then they can have £50,000 in a savings account and will still pay no tax on their income from those savings. Even if they earn 4% interest (those days seem like a distant memory but who knows they may return) then someone with £25,000 of savings would still pay not tax on their interest.
Non-taxpayers won’t have to reclaim the 20% tax deducted from their income: At the moment, banks and building societies have to deduct 20% tax from all interest income before it is paid out and non-taxpayers have to reclaim the tax withheld. In many cases, this money is never actually claimed as the recipients do not know they have to do so. Pensioners are one of the groups least likely to reclaim the tax, so this will be of benefit to them.
Higher rate taxpayers will have to pay the additional tax above basic rate and the top 5% of savers will still be able to shelter money in ISAs to receive tax free savings income.
ISA savings will also become more flexible: At the moment, if you invest the full £15,240 into an ISA at the start of the year and then take some money out, you cannot put more back again that year. In future, the Government plans to allow you to put money in, then take it out again if you need to and reinvest back up to the full annual ISA allowance later in the same tax year. It is not clear how this will be tracked and I can foresee some administration issues, but the principle is a good one.
So what about pensions – some good news, some not good news: After last year’s bombshell, we could not possibly expect a similar scale of change. Building on the pensions revolution started in last year’s Budget, the Chancellor wants to extend the new idea of freedom and choice much more widely. However, to pay for the giveaway to savers, the lifetime limit on pensions has been cut sharply again.
Undoing unwanted annuities: The pensions revolution that proved so popular last year has been extended to try to include those who had already bought annuities before the rules forcing most pension savers to buy annuities were scrapped. The Chancellor intends to offer those who were previously forced to lock their pension funds into irreversible annuities, the chance to sell them again. Many never actually wanted, to annuitise or bought unsuitable products and understandably felt most aggrieved that future pension savers had freedoms they were denied. So a consultation has been launched https://www.gov.uk/government/consultations/creating-a-secondary-annuity-market-call-for-evidence that proposes allowing people to sell their annuities. They will receive a cash lump sum that they can either spend – but will be taxed on as income – or can reinvest into a pension drawdown fund and then only pay tax when they withdraw their money. This is a fair and sensible policy.
Regulatory protection and advice crucial: Of course there are dangers that people will be ripped off if companies buying their annuities offer a poor deal. Many annuitants paid high charges when buying the annuity in the first place or received poor value, so that would be adding insult to injury. Therefore, we need careful regulatory oversight of the second-hand annuity market, perhaps with controls on charges and making sure people get proper independent advice before trading in their annuity. The Pension Wise guidance service is likely to be extended to offer help and information with the decision, but advice and regulatory protection are really needed. Of course, nobody will be forced to sell their annuity. It will be their choice, but one which they would not otherwise have.
There are circumstances in which allowing people to sell their annuity will be sensible: Those with small pension funds and plenty of other retirement income may welcome the chance to take the cash for urgent expenses or debt repayment. Others may need to provide a pension for a partner which was not included in their annuity. Those with guaranteed annuity rates that only offered single life products will have a chance to cover their partner and those who prefer to leave their pension money invested for a few more years will be able to do so, whereas under the old rules they would have needed huge sums (around £100,000 or more) to be able to use drawdown. Controls on charges or other customer protection might be needed, but at least people will not be stuck for life in an unsuitable product.
However, the other big change to pensions is far less welcome: Cutting the lifetime limit from £1.25m to £1m is very disappointing. Indeed, in 2014 the lifetime limit was still £1.5m, it is now £1.25m and cutting it down to £1m is a draconian change. Cutting the lifetime allowance so sharply makes it much harder for people to plan their pension savings over the long-term. This is expected to raise £600m in extra tax revenue and will hit many people in final salary or defined benefit pension schemes, as well as those in defined contribution pensions. The Government suggests that only around 4% of pension pots are above £1million and that it will offer protection for those already near or over the limit, however it is really a shame that this policy has been introduced.
Lowering LTA adds more complexity and penalises investment success – both are bad for pensions: Firstly, it makes pensions still more complicated by adding yet another layer of protection into the rules. Secondly, it is a penalty on investment success. Surely the point of pension saving is to benefit from long-term investment returns. That means it makes sense to limit the amount people can put in with the help of tax relief, but does not make sense to then try to punish them if their fund grows sharply.
Lifetime limit far more generous for DB schemes than DC: The lifetime limit of £1m will allow members of defined benefit (final salary/career average) schemes to have a pension of up to £50,000 a year within the limit. However, members of defined contribution pension schemes (which is the majority of workers outside the public sector) could only buy a pension worth around £25,000 for £1m (with inflation linking and spouse protection), so the lifetime limit is unfair in this respect due to the calculation methodology of the rules.
A lifetime limit for DB schemes makes more sense, but should be abolished for DC: For members of defined benefit pension schemes, who do not have an actual pot of money but are promised a specific level of pension, perhaps the lifetime limit makes more sense, since they have no control over the investments and the contributions are harder to measure due to fluctuations that occur depending on the scheme’s assessed funding levels. With defined contribution schemes, the better policy would be to control the amount put in each year but then allow the pot to grow as well as it can, without penalising it if it rises strongly. Therefore, I would like to see the Lifetime allowance abolished for DC schemes.
Nothing for long-term care: It is disappointing that there are no new measures to help or encourage or incentivise people to put money aside for funding long-term care needs. Families are not prepared for care, nor is the Government, yet there is a crisis looming which could eat up the resources of many families who might have been able to put some funds away if they had known about it – and could also bankrupt the NHS. The next Government will have to get to grips with this crisis urgently, time is running out.
Help for younger first time housebuyers with a pension-style ISA plan: The new ‘HelptoBuySA’ effectively turns the savings of young people preparing for their first house purchase into house pension plans, by offering the equivalent of basic rate tax relief on their savings. If they need a house deposit of £15,000 for their first home, they will only need to actually save £12,000 and the Government adds the additional £3,000 they require.
March 18, 2015 2 Comments