The phoney give-away
The most accurate measure for the success of private pensions in the UK is the replacement ratio; a measure of what percentage of people’s pre-retirement income is replaced by savings specifically for retirement.
Steve Webb and the DWP are beginning to chart the nation’s progress from historically low levels of replacement (following the near collapse of the private sector defined benefit pension scheme) to something like adequacy.
Even by the most optimistic forecasts, any recovery will take a minimum of 20 years and though the new system of auto-enrolment for all and a return to a proper basic state pensions is likely to mean a fairer pension system overall, currently there is a huge gulf between the pension haves and pension have nots.
For the vast majority of middle Britain, there simply is insufficient in private pensions for George Osborne’s vision of inheritable pension wealth to mean anything. There is more capital tied up in most people’s garage than their pension.
Organising people’s decision making from 2015 onwards around the inheritable value of the pension pot may be realistic for the top 5% of DC savers for whom the annual allowance that can be paid into pensions (£45k) and the Lifetime Allowance that can be built up £1.25m) are meaningful figures. But most people struggle with the auto-enrolment proxy of 4% of salary and the average pot is £30,ooo, about 1/40th of the maximum allowance.
So George is kidding us and for those in the pensions industry trying to get some sense into people’s financial planning, it is deeply unhelpful for the Chancellor to be parading tax hand-outs for the super-rich as incentives for the pension poor.
We are not pension affluent, as a nation we are pension poor and we need to look at other ways to solve the problem than kidding people otherwise.
Corroding the good work of the past five years
There is another way of approaching the pension problem. It is not as sexy and it may not be as politically attractive, but it is the responsible way.
The underlying problem facing the nation is that we are living longer, we are not getting wealthier in retirement, we are getting poorer, having to work longer , facing the uncertainty of long-term care and the ignominy of decrepitude without the means to be self-reliant.
Those who die in the first few years of retirement (and 75 is still pension young) may give their kin a fillip (estimated at an average extra legacy of £500) but they will be few in numbers, only a few die young.
To qualify for this extra legacy , you must be planning to die young and risk living long. For you will have to keep your money invested in your own pot. It looks unlikely that you will get any benefit from the Chancellor’s generosity from any form of collective pension-(annuities, defined benefit or collective DC).
That is because all three of these means of receiving a pension are based on a mutual pool which works by people collaborating and putting aside their obsession to beggar their neighbour.
An unfair policy which will only benefit the “pension super-rich”
This might seem obvious and it would be were we not so dead set on aspirational wealth. The idea of individual self-reliance is conceptually attractive, it plays well at conferences, with the media and at the hustings.
But there is a dirty underbelly to the “I’m alright Jack” world of George and his right wing associates. For them it’s every man for himself and bugger the consequences. The consequences are seldom felt by those in power, they are inherited by those who have no power.
At a time when Defined Benefit pooling is on its knees, annuities “a dirty word” and the new-pooling of CDC still in gestation, the Chancellor’s craven use of populist pension policies to see off UKIP and secure political brownie points with aspirant Britain is nauseous.
The obvious solution
There is a very simple way of taxing with the transfer of wealth from generation to generation, it is inheritance tax. Inheritance tax, were it to be applied to pensions would only impact the genuinely wealthy. It would not give an exemption to those super-rich under 75 , it would tax them on their pension wealth, it would give the same exemption to those with total wealth below the IHT threshold (currently £325,000 for singles – £650k for couples)
By using inheritance tax to determine who paid tax when people die too soon, we would have a system that was fair across DB , DC and DA, the residual values of “pooled” pensions are of course zero, this means people inherit nothing but get no tax-bill. The residual value from individual drawdown will be easily valued and will only be taxed where the overall value of the estate is sufficient to leave a meaningful legacy to the next generation anyway.
So what does this mean?
George Osborne is, by exempting DC in drawdown for those dying under 75
- building in unnecessary complexity into a tax-system which is fit for purpose as it stands(IHT)
- creating an unhelpful bias in the guidance system towards individual drawdown and away from pooled solutions
- kidding the population that it is pension wealthy (when it is not).
Some good people have praised the Chancellor for his giveaway, people that include Ros Altmann and Malcolm Mclean, but I think they too have been fooled by George’s blandishments. The £150m pa giveaway will be focussed on a small band of high-net-worth individuals using drawdown who have the misfortune to die before they are 75, for the rest of the population , the £150m will pass them by.
Don’t get fooled by this tax-break, it is almost certainly not going to break in your direction. Let’s get on with the business of restoring confidence in pensions through better savings, better products and better education and not be diverted by political shenanigans from a Chancellor who should know better.
spot on!
Candidly Henry I am unconvinced by your blend of passion and fact. Your dogged pursuit of CDC may be well placed but it is devalued by the nature of your employer. DC may not be the best way to deliver retirement futures for the unpensioned many but Webb’s drive and Osborne’s facilitation are beginning to re-engage millions with a better future.
Henry – some good points, but I’d say it is the additional negative about annuities, and thus its knock-on effect on people’s view of CDC, that really incenses you. In my company I was always pushing the mortality risk re annuities – ie the risk of dying ‘too young’. I actually christened it ‘shortevity’ to point the contrast with drawdown.
It’s even built into the principle of the risk, isn’t it? Only half of us can expect to get good value from an annuity (if you ignore the insurance companies’ cut), and the other half won’t. Mortality cross-subsidy is just a poncey way of putting it.
So, a fall-back for those of us who think we might not make the 50% cut, of being able to pass on what’s left to our kids, has some value.
If everyone who had less confidence in their life expectancy than the insurance company took that view, and avoided annuity options, then annuities would become even worse value. It remains hard to give advice, though easy to point out all the considerations.
So, the best annuity anyone can get (enhanced for two thirds of us) has to remain the benchmark for comparing any more risky option.
And, while I too like the sound of CDC, I think the possibility for each of us to have our annuity underwritten might be a bigger obstacle on the path to the adoption oif CDC than the current simplistic ‘annuity = bad’ approach.
You can criticise all you want but any positive spin on pensions that gets people to view them as a “good thing” can only encourage saving. Most clients in their 30/40’s are not worried by annuity/drawdown choice making but all like the idea of flexibility.
I agree with your comments about the use of policy to appease aspirational people who will aspire to but never actually acquire meaningful wealth. The rest is about numbers but it would appear to me that George has used pension policy as the 2015 version of the great 1979 council house sell off election vote winner.