Josephine Cumbo continues to write with precision about the need for reform of the pension taxation system. If you can’t read her latest article, perhaps you should think of subscribing to the FT – at least to read her output over the past three years. I’m writing this blog for two people especially, Jo Cumbo and Baroness Ros Altmann – who have influenced my thinking about pensions more than most! Both are thinking big thoughts about pension delivery, and both are considering reform.
The case for reform
- Current tax concessions that should be encouraging those at the top of organisations to promote pensions , have been so curtailed that many high earners view the pension taxation system with resentment.
- The vast majority of the £50bn lost to the exchequer from the various pension tax-reliefs is benefiting those who are likely to be wealthy in retirement
- Those on low incomes are not being incentivised to save by tax, and indeed are often missing out on promised incentives.
So fundamental are these problems, that I have argued we need to think from the bottom up about how we allocate money to solve the problems of the nation’s ageing society.
These problems are simple. People are living longer and are more expensive to the state in extreme old age. Longevity is a problem of dependency , the old on the young, those in retirement on those in work. Ultimately we are going to have to re-prioritise who is paying for who.
What is going right
There are large parts of the pension system that are going well. This week, the PPF rescued the 1000th group of pension scheme members who could not be supported by failing employers. The PPF is a great success.
Secondly, we have a state pension that is simpler and more generous than it was. It provides a much more meaningful safety net and it means that together with universal credit, deep poverty amongst the old is reducing.
Thirdly, we are beginning to rebuild a more democratic retirement savings program where nearly everybody is “in”, albeit not in it so deep as the lucky few still accruing a defined benefit.
What is going wrong
I have three major issues with UK pension system
Firstly, it treats pensions and health independently, the increasing problems of our NHS are mainly because of the failing health of pensioners. Those in work are picking up two bills, the bill for pensions tax relief and the bill for the strain on the NHS. The two bills should become one. We need to think about prioritising the NHS and diverting the money that makes people like me wealthy, towards paying for people like my later life healthcare.
Secondly, we need to make private pensions popular for everyone. Right now, the millions of new pension savers, auto-enrolled into their savings plans, are not appreciating their savings. Pensions are just another deduction from the payslip. Those who don’t pay tax and those who pay basic rate tax benefit from contribution reliefs at between 0% and 20%. Meanwhile those who are on higher earnings get contribution tax-relief at between 40 and 45%. The benefits of tax free growth are similarly skewed towards those who pay higher rates of income tax, those who pay CGT and those with inheritance tax liabilities. Small wonder that those on low-earnings don’t value their pension savings.
My third issue is that as a nation we have lost the focus of saving for retirement which has always been to be able to become independent of work from having an independent wage in retirement. We increasingly talk of our pension in terms of wealth and not in terms of lifetime income and this has broken the link between work and later life social security. Private pensions has been hi-jacked by the financial services industry and are now part of “wealth management”.
Why pensions will never be ISAs
Earlier in the week, I took issue with Baroness Altmann and she took issue with me!
I said that her solutions to the radical overhaul of pension she was proposing were not fundamental. She said that my solution would destroy the pension system by turning pensions into ISAs.
But here is where I have a card up my sleeve. My solution to the great reform of pension is do three things
- Turn the tax privileges of pensions around by changing the relief system to TEE
- Transition from EET by extending scheme pays
- Establishing CDC as the default decumulator with annuities and drawdown as alternatives for the financially sophisticated.
And here I declare that I would abolish the “freedom” to cash-out pension savings other than in extreme circumstances. I would keep the capacity to withdraw 25% of the “pension pot” but I would not incentivise people to do so , by giving this 25% further tax privileges. In my view of the future, all income from annuities, from drawdown, but primarily from CDC pensions would be paid tax-free, as would any initial lump sum.
Why CDC is an “in-retirement” solution
The savings system we have in this country , which is increasingly known as “workplace pensions” but which is more exactly “defined contribution” no longer purchases pensions . It is not “money purchase” and hasn’t been since George Osborne announced in 2014 that no-one would every have to buy an annuity again.
But – as a means of building up wealth for retirement – it is working very well. I am proposing that we return DC to “money purchase” by creating a system of CDC pensions into which people can transfer their DC pots in exchange for a wage for life- paid by the CDC provider.
I propose that the Government is as bold in setting up a CDC provider, as it was in setting up NEST. Indeed I see NEST as being extended into the Government’s CDC provider. I see the Government’s CDC provider as already in existence. It is the payer of pensions to the members of a thousand pension schemes. It is the PPF.
CDC and the PPF
In the early days of planning for auto-enrolment, people confused auto-enrolment and NEST and used the two interchangeably. It was only when auto-enrolment got going that rivals to NEST emerged and we got the competitive market we have today.
I see the next decade as one where we have the same dynamic in decumulation. If the Government has the courage to get behind CDC as a way of turning DC pots into a wage for life, then it should convert the PPF into a seeded CDC pension scheme (ring-fencing the PPF’s current membership who will continue to enjoy guaranteed pensions.
The non guaranteed part of the PPF will take money in from private individuals (in their millions) and pay pensions – according to the PPF’s capacity to pay those pensions. My guess is that the PPF will pay quite low pensions because the PPF is uber-cautious. My guess is that people will be prepared to look beyond the PPF and they will find a variety of private alternatives ranging from the raciest drawdown promises to the most sedate of annuities. They will be able to choose how they want their retirement wages paid to them but the benchmark will be the PPF.
A system depending on “open finance”
My vision for the future is underpinned by technology. For me, “open pensions” means that we will be able to see our retirement plan building over our working lives , and to see that – as we will see everything – delivered to us by digital technology. We need open finance to get open pensions. As with CDC, the Government are getting this.
I don’t know what the device will be, or how far we will deliver via smart contracts and whether something new will come along which will make our current thinking about delivery redundant. I suspect that how we get our information, take our decisions and get paid in retirement will be radically different to what happens now.
But I am sure that whatever the Government’s current vision for the dashboard is, it will be obsolescent by the time it delivers it and that technology will deliver much of what I have been talking about in this blog.
Technology will deliver the means for the Treasury to plan the move from EET to TEE and re-prioritise tax to both incentivise savings and save our NHS
Technology will help pension providers and payroll manage the impact of transitioning from EET to TEE
Technology will help us find our pensions (the basis of the pensions dashboard)
Technology will power open pensions that will enable to convert pension pots into retirement plans.
Technology will ensure that CDC is set up fairly , with Smart Contracts, between all current and future participants to ensure sustainability
Technology will drive innovation in the market to allow the private sector to compete against the PPF for in retirement wealth.
Technology will allow ordinary people to balance the books so that they can spend their retirement not having to worry (so much) about money.
Making Britain #1 for pensions once again
Free-flowing information will be at the heart of this. Information is data, data will mean we have the money we need at the right time and in the right place.
It will mean that we will have a more certain and more sustainable system of long-term care.
Crucially, without the guarantees of state pensions, defined benefit pension schemes and annuities, we will be able to integrate the funding of our great infrastructure projects, especially our NHS, into a financial model that is driven by Britain’s productivity.
We are in a position now to think outside the constraints of European law and establish a solution for the latter part of this decade and the decades to come which is world-beating.
A note for Guy Opperman
I know that some people in the DWP read my blog and I hope that from time to time , some of my ideas may filter up to the Pensions Minister.
Guy Opperman is someone who has sponsored CDC through to the Pension Schemes Bill and for that he deserves great credit. He has also helped keep the vision for the Pension Dashboard alive – I thank him for that.
Now I give him a third challenge. I challenge him to work with HMT on this great issue of pension taxation. I challenge him to work with other departments , especially the department of Health, to work towards a joined up solution to the problems the current generation, my generation and future generations are facing and will face as we get old.
When Guy Opperman came into the job of pensions minister , he told us he was doing the job for the job’s sake. He said he was doing it to extend pension’s reach to those currently excluded. He has been true to his word.
He now finds himself with the opportunity to become the longest serving Pensions Minister in living memory. He is part of a strong Government with a fixed term of five years ahead of him. There is a (relatively) open legislative opportunity ahead of him.
He has people in Government , such as Ros Altmann who can help him. I send him this message. There are plenty of people like me who want to see Britain become #1 in the world , in the way we manage our pension system. We want our healthcare system to be #1 in the world too.
The forgotten Pensioner
Many retired people live alone on minimal incomes
It would be helpful if those of us lucky enough to get retirement planning right
”adopted” a less fortunate one and gave them some time and conversation,
If we would set up a covenant for say £50 pw that did not damage their State benefits it would go a long way to pulling them back to the other side of the poverty line.
I have seen this work with very positive results for all parties concerned
What a good idea
The New State Pension is less generous than the system it replaced. Please don’t ignore SERPS/S2P.