Telegraph article on how pension reform affects you
by Dr. Ros Altmann
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PENSION REFORM – HOW IT AFFECTS YOU
The UK has built up a powerful retirement savings culture in past decades, but recent events have weakened this substantially. Pensions have been hit by so many problems – mis-selling scandals, Equitable Life, closure and failure of company schemes, tax increases and more. The Government’s response has been to introduce piecemeal reforms, such as stakeholder pensions, Pension Credit and now the Pensions Bill itself. Many people may be confused about what all the changes will mean.
The recent reforms are supposedly designed to restore confidence in pensions and encourage more people to contribute to pensions in future. I am concerned, however, that the outcome of the package of measures may be to further undermine pension provision, because there is still a lack of ‘joined-up thinking’ on pensions policy.
One of the main risks is that pensions may become a form of saving that people only do when they are older, particularly once they reach the higher rate tax band, rather than when younger or on basic rate tax.
For most basic rate taxpayers, the interaction of the State pension system with the reforms in the Pensions Bill and Finance Bill, have made pensions even less attractive than before. The big problem with pensions is that the money put into them has to be locked away for decades, until retirement. Even in an emergency, it can’t be taken out. This means people have to be pretty sure they can afford to part with the money, before putting it into a pension. The only real incentive that people receive for locking this money away is in the form of tax relief (and this costs the Government well over £10billion a year). Now, for top rate taxpayers, tax relief is a pretty good deal. For every £3 they put into their pension, they receive another £2 from other taxpayers. But people who only pay basic rate tax (well over 80% of taxpayers) only get tax relief at basic rate. So for every £3 they put into their pensions, they get just another 85p.
At the moment, there are strict and complicated limits on the amount that you are allowed to put in each year, depending on your salary and your age. This means that, unless you save regularly over the years, you are unable to build up a very large pension pot. However, the Government’s pension reforms will introduce a new pensions tax regime from April 2006. There will be no complicated annual limits on how much you can put into your pension. If you wish, you will be able to put in 100% of your salary each year, with full tax relief, and employers can put in even more for you. There will just be a limit of around £215,000 per year, (but more if you are only a couple of years away from retirement) plus an overall limit of £1.5million worth of pension savings over your working life.
This means that, before April 2006, if you are not very far from retirement, you need to consider all the pensions that you have accumulated over your lifetime and take independent financial advice about whether you need to elect to ‘protect’ the accumulated savings. If you have not protected your pension and your accumulated funds are above the £1.5million limit, there will be a tax rate of 55% to pay on any excess, so checking to make sure you do not fall into this category will be important for many high earners.
For others, however, rather than locking money away in the form of pension contributions when young, if you think the new regime will last, you may simply decide to leave pension contributions until the last few years of your working life and save in a different form before this. It certainly makes much less sense to start contributing to a pension when only paying basic rate tax. The incentive of basic rate tax relief is not enormously attractive.
The interaction with the means tested Pension Credit of the State pension system, makes this situation even worse. Forecasts suggest that over three quarters of pensioners will be caught in the Pension Credit means test in future. This would result in at least 40% of any private pension savings being taken away by the means test on retirement. So the offer of tax relief at 22%, in the face of the threat of losing over 40% of any pension income, suggests that most young people should think very carefully about whether to save in a pension at all.
One problem is that the Government has so far only concentrated on the supply side of the pensions equation – making the system easier to understand, offering more information, leaflets, decision trees and cheaper products – but has not addressed demand. Unfortunately, the coming pension reforms do not include any new incentives to encourage individuals or employers who were not making pension contributions before, to think about doing so in future. New incentives are essential, if we really want more people to save.
My fear is that the law of unintended consequences may result in these latest reforms doing further damage to the retirement saving culture which was once the envy of other countries. There may no longer be an incentive for people to think about pensions over their lifetime and pensions may simply become another perk for the top earners. If top Directors simply use pensions to squirrel away large sums of money with generous tax relief when they are close to retirement, they may be even less likely to worry about providing pensions for their workforce. If means testing removes the incentive for basic rate taxpayers to save in a pension at all, then the Government’s pension reforms could actually emasculate pension provision for the future.
What we need is bold, radical change, to provide clearer incentives and remove the disincentives, making middle Britain believe, once again, that it is worthwhile putting money into pensions for their future well-being.