A Savings Revolution to follow the Pensions Revolution
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.