Will major pension reforms be put on the back burner?
The pension minister's role has been downgraded to a more junior position, and in the wake of the Brexit vote the current government will have other, bigger fish to fry for years to come.
Ros Altmann, pensions minister under David Cameron's premiership, knows all about the pension policies under scrutiny, from the 'triple lock' to the Lifetime Isa (Lisa) and a potential overhaul of pension tax relief.
So which are the most likely to go ahead, and which are set to be dumped under the new regime?
Since 2010, the triple-lock policy has meant that pensions rise by whichever is highest of the inflation rate, average earnings or 2.5%. In his election manifesto Cameron committed to the triple lock until 2020, but what will happen afterwards?
“The law just says pensions should go up in line with earnings,” explains Altmann. She argues that while pensioners need more certainty than the law currently provides, politicians should not feel they can't move away from the triple lock.
Altmann suggests moving to a 'double lock' after 2020, to give pensioners the better of either prices or earnings inflation. "It is dangerous for public finances and for pension policy as a whole to bake in a 2.5% figure that doesn't relate to anything in the economy.
“Moving to a double lock leaves it to the government of the day to assess the state of the economy and adjust pensions accordingly. And actually when you do the numbers, you save a lot more money by changing the uprating of the pension than you do by increasing the state pension age.”
The problem with continually raising state pension ages is that it is unfair on certain groups. There is a marked variation in life expectancy in this country: low earners, people with heavy manual labour jobs and those who live in industrial areas have lower life expectancy.
“They still contribute to national insurance all the way through their life; they just don't live long enough to benefit from the pension consequences, and that seems unfair,” says Altmann.
Moreover, she adds in reference to the cohort of women who have been additionally disadvantaged by rises in their pension age which they were not warned of, the government seems to be pretty poor at telling people about changes to state pension age.
“It would be preferable to manage state pension costs more flexibly.”
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “The triple lock was never going to be sustainable in the long term and for as long as it exists, it will divert an ever-increasing share of government spending towards pensioners, at the expense of the working population.
“A balance needs to be struck between protecting the standard of living of pensioners, and not over-burdening taxpayers. There is a strong case for using a dedicated pensioners' RPI measure for inflation-proofing the state pension, rather than either a triple lock or the double lock proposed by Ros.”
Altmann believes the country is ready for a fairer system of saving incentives for pensions.
“The costs of the current system are significant - potentially around £40 billion a year, which is huge - but the majority of it goes to higher earners. The people who need more help with pensions are not the higher earners.”
She explains there are a number of drawbacks in the current system of pension incentives via the tax system. First, giving incentives through a progressive tax system is regressive, as more incentives are given to people who earn more.
Secondly, the system is complicated and opaque, which means that “if you've got an incentive that's meant to encourage you to save more, but you don't know what you're getting, it's inefficient”.
Under the current system, someone who pays 40% tax will end up with a pension one third bigger than someone who puts exactly the same money aside but is only a basic-rate taxpayer, notes Altmann, even if they earn exactly the same returns all their life.
“Moving to a flat-rate government contribution to your pension that people can understand, the same for everybody, better than basic tax relief but obviously not quite as generous as higher rate, would be fairer and more effective in helping more people have better pensions.
“You could badge it as the government contribution to your pension - you pay in £3 and the government gives you another pound. Everyone can understand that.”
Gary Smith, a financial planner at Tilney Bestinvest, says: “It is clear that the government will have to reduce the cost of pension tax relief to the exchequer, especially if it were to remove the ‘lifetime allowance’, but a fair method would be to introduce 30 per cent across the board.
“Not only would this make savings against those who benefit the most, but it should also assist lower earners in building up a retirement pot.
“Ultimately, statistics suggest this would be a net receipt for HMRC while still being highly tax-advantageous to higher taxpayers - comparable with tax-efficient investment vehicles such as venture capital trusts and the enterprise investment scheme.”
Although the new Isa has 'lifetime' in its name, Altmann points out that the behavioural incentives in it mean it won't last a lifetime. “A pension needs to last to your 80s, but a Lisa will encourage you to spend it all in your 60s.
“There has been some resistance in the industry to actually launching it. The government has only just issued its consultation on how the product might work.
“It is proposing that anyone who wants to take money out of the Lisa early, unless it's for house purchase or terminal illness, will lose the taxpayer bonus and also face an extra penalty - possibly more than 5% of their fund.
“There is also a real risk that people will invest in this product instead of their workplace pension and end up significantly worse off, losing their employer contribution and higher rate tax relief on contributions. Who will ensure they understand the risks and check this product is suitable?”
Altmann suggests that wealthy investors and families could benefit, but “from a social perspective the Lifetime Isa is unlikely to help the people we most need to worry about in terms of pensions”. She says she would prefer more equitable pension incentive spending with a long-term perspective.
Of the second-hand annuity market, which is scheduled to launch in April 2017, Altmann says: “I would always expect it to be a niche market.”
She emphasises that there has to be proper consumer protection. Questions on who would advise people need to be answered: how much would they charge and how would they assess the risks?
“What you'd need is some kind of centralised system which helps you work out whether you're being offered good value - who is going to set that up?” she says.
“I haven't seen a huge sense of urgency on this from the Treasury. It's meant to be coming in next April and I know there are a lot of people who are desperate to sell annuities. But I'm not convinced it will go ahead on time.”
Looking forward long term
“If [economist and social reformer] William Beveridge was designing the welfare state today, unquestionably he would build in a national insurance scheme for long-term care,” says Altmann. In his day the concept of living 40 years past pension age was not on the cards.
“From an inter-generational perspective, there is going to be a lot of pressure on a smaller cohort of middle-aged people, and it's not clear where the money is going to come from to support the ever-increasing number of older people, but it will have to be found.”
Working longer is part of the solution, Altmann notes, including part-time working into later life. “These social shifts take a long time - there's still a lot of age bias in the labour market.
“But younger people's pension prospects are not as good as any of the current generations. With auto-enrolment we're on the right path; I just hope nothing derails it.”
David Newman, head of pensions at Close Brothers, says: “People want stability if you give them responsibility. Ideally I would want to see 25 years of no more tinkering with pension policy, but that's never going to happen.
“If they're struggling to make a decision on Heathrow versus Gatwick, how will they make any decisions on pensions, which are so much more important?”
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Enterprise Investment Scheme
A scheme set up to encourage investment into small, unquoted trading companies and give investors tax breaks to compensate for taking risk. Because the companies in the scheme are not listed on a stock exchange they often carry a high risk, so the tax relief is intended to offer some compensation. An EIS company cannot be a subsidiary, must trade wholly in the UK, can’t employ more than 50 people and certain activities (including forestry, farming and hotels) preclude companies from offering EIS relief.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.