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Pensions reform 2015: it's not just about retirement saving

Out-Law Analysis | 22 Sep 2015 | 4:49 pm | 6 min. read

FOCUS: Very few of us are ever going to have enough money in retirement to do everything we might want to do, so we need to think outside the current pensions 'box' if we are going to have anywhere near enough.

The government's Green Paper has been billed as being about reforming pension tax relief, but it is about much more than that. One clue is in the first part of the title: "strengthening the incentive to save" is about saving more, period. Financial advisers would certainly recognise the need – the regulatory duty, even – to look holistically at the needs and wants of their clients and all their savings across the board when dispensing advice about retirement income planning. So it would be dangerous to pigeonhole this most recent consultation into the 'pension tax relief' inbox.

It's not just about the cost of government support – the tax relief – either. Let's face it, the reason we have the Green Paper is because the government wants to put the public finances back on track. Action has already been taken to restrict the lifetime and annual allowances, so this is not about capping the rising cost of tax relief claimed by the wealthy. For a government elected to restore the UK's economic security, the prospect of saving an even greater portion of the current £21 billion net cost of pension tax relief is just too good a trick to miss.

This article therefore sets out some thoughts about the impact of the Green Paper's suggested options for reform across a much wider horizon.

Planning for income in retirement

In many cases, planning for income in retirement will take into account alternative, non-pension products, such as savings in individual savings accounts (ISAs). How other needs could be satisfied, such as long-term care costs, will also be relevant to some people. Releasing equity from homes could provide significant retirement income, and functionality of online platforms offers other options. Failure to include these, and other wider wealth management considerations, in future thinking could lead to unintended consequences and potentially lead to a distortion in the long-term savings market which could result in potential detriment to all.

Since their introduction, ISAs have been one of the most popular savings vehicles and it is easy to see how some of the options in the Green Paper, such as an ISA-style pension tax regime, could be popular, easier to understand and simpler to administer. But the attraction of such a regime would be diminished if the 55 years age restriction on cashing in is maintained for these new pension products, if they only gain some weak form of government contribution and the 25% tax free lump sum option is lost.

For years, the ISA's long-term prospects were troubled by the threat that the product was only going to be available short-term. With more recent government announcements providing longer term commitments to secure the opportunity to save in an ISA, the product has become the first destination for many with the desire to "put some money by". However, the ISA serves only medium-term savings needs. It is a rare, disciplined saver who is not tempted to take money out of an ISA after a few years - and why not? Moreover, cash ISAs are simply deposit accounts with a little bit of tax incentive which means little, if anything, to many. Deposits come and deposits go - not a good outcome if trying to create a pension pot for 20, 30 or 40 years down the road.

The ISA is a popular product which serves its purpose well - but it shouldn't be confused with pension saving, and the tax treatment of ISAs should not be the blueprint for how pension tax relief should be allowed to develop. Encouraging people to save for the long term requires much stronger incentives than are possible with an ISA. And, if an ISA-like taxed product is considered the way to go, with an age 55 restriction on access to funds and miniscule government incentives, I know where most of the savings will go. Not into pension products, that's for sure.

And what about planning for the cost of long-term care? No one knows if they are going to be in need of such care, what form it will take and what it might cost. The insurance industry was encouraged by the previous coalition government to formulate products for this market, but it concluded that it was not worth spending development money to launch care fee products due to the simple fact that long-term care was even further away than pension savings in most people's minds and there was simply no immediate demand for such products.

The government's reaction to delay the introduction of a £72,000 cap on care fees until 2020, having legislated in the last parliament to start it in 2016, was not a good sign. Going back on commitments is just the thing to put off pension savers: can we trust the government to commit to leaving pensions income untaxed, in line with savers' expectations, and not to take some of it away in tax when needed to rebalance the economy at some future point?

A flat rate of tax relief for all long-term savings

Bearing all of this in mind, the government should create a flat rate of tax relief for savings intended for pensions or long-term care fees wherever that money is kept. In other words, recognise the need for support according to the intended use for the savings, and not the vehicle employed to do so.

Every section of the population needs to save for retirement, and the age 55 restriction is a good way of ensuring that this is done. A flat rate of tax relief at the point of contributing savings, and which is embedded and kept sacrosanct for 30 years, would be easy to understand and would let people save with confidence.

The way forward, in my view, is this:

  • leave ISAs and their tax treatment as they are – they work well for savings in the short to medium timeframe, but their tax regime should not become mixed up with long-term pension savings;
  • long-term pension savings need different and stronger tax incentives to save;
  • nobody trusts the government to commit to leaving pension income untaxed and not to take some of it away in tax when needed to rebalance the economy at some future point – but people's pensions, built up from their own money, should not be available for governments to play with;
  • saving for long-term care needs to be incentivised – of all the helpless people who the government should support, it is the beneficiaries of care that should be put first in the queue for tax relief incentives;
  • create a flat rate of tax relief for pension savings and care fee plans wherever the money is kept;
  • keep the age 55 restriction; and
  • scrap the lifetime and annual allowances – these are now too confusing and penalise good behaviours.

Saving for a pension can be a very distant objective for many, particularly the young and low-paid. Incentivising them to save over and above auto-enrolment contributions will be difficult. And it will be completely impossible for some people to save much, if at all - whether because they are unemployed or because they have more important priorities for the time being, such as paying off student loans or saving for the deposit of a new home.

The government's role in encouraging pension savings must therefore be carefully tailored to ensure that its support is appropriate for each section of the population and enables a spectrum of solutions to be created that will facilitate the best outcomes possible for each one. And this would also include the well-paid. Creating a tax regime that destroys the interest of the well-paid in long-term saving for their retirement, for example by scrapping tax relief entirely, would be a bad outcome for the government's finances and could substantially reduce interest in pension saving in the UK.

Failure to include these and other, wider wealth management considerations in future thinking could lead to unintended consequences, and could potentially lead to a distortion in the long-term savings market - which could result in potential detriment to all.

Bruno Geiringer is a life insurance expert at Pinsent Masons, the law firm behind Out-Law.com. This article is part of a series dealing with the government's pensions tax relief consultation, Strengthening the Incentive to Save, which closes on 30 September 2015.