Who and what are pensions for?
The most telling comment in the IFS’ most recent output is a quote from their “Death Taxes and Pensions”
we currently have ‘the bizarre situation where pensions are treated more favourably by the tax system as a vehicle for bequests than they are as a retirement income vehicle’.
If we are to have a philosophy of pensions, then it should lead to a common statement of purpose as it has in Australia. We needn’t get hung up on the phrasing , but we must tied down the “who and what”.
In my view of pensions, they are about providing dignity in retirement through the payment of income that lasts as long as the pensioner.
This is an exclusive definition because it does not include a statement about “savings” or “wealth” and it excludes the mitigation of death taxes from what pensions are for. If the wealthy want to have pensions, good. But they should not confuse them with bequests.
Pension is not about savings
There are two ways of getting a pension. You can either buy it as you go along – which is how you get the state pension and how a defined benefit or CDC scheme works. Or you can buy one out of your savings, which is how DC pensions use to work and should work in future.
Pensions are not savings, no matter what the Pension and Lifetime Savings Association would have us think. Like the ABI, they have confused pensions with wealth and forgotten the fundamental point of a pension – an insurance against living too long.
Of course savings are important in retirement, but they are different from the pension. I am not opposed to the spirit and sentiment expressed in this statement by the ABI (and by association the PLSA). But the lack of definition is alarming. Savings and investments are not the same as pensions but we have conflated the two and are confusing ourselves and our customers.
I take issue with the idea of putting “savers” at the heart of any pension policy. The heart of any pension policy is the pensioner.
Should pensions be a store of inheritable wealth?
The current system puts too much stress on retirement saving and too little on insurance against old age. We have forgotten the “who and what”. Pensions are for people who want and need a replacement income in retirement. They provide an income that lasts as long as the pensioner does (with protection for couples).
People can opt out of pensions using their pension freedoms and many rich people whose income needs are taken care of elsewhere, may opt out. But they should not be incentivised to opt-out by a tax-system that encourages pension money to be redirected to finance inheritance.
The debate we are having prior to the July 4th election is about pensions – the state pension. The state pension is not inheritable (other than to spouses). The public understands pensions in terms of the state pension and the works pension paid on top by an employer through a company pension scheme.
Retirement savings no longer purchase pensions or their insurance derivative – annuities.
There is a strong and vigorous lobby to protect retirement savings as a means of tax-free bequest, but as the IFS points out, this is at the expense of pensions. Pensions must be exclusive and not be confused with savings and wealth. If you are saving for wealth – good luck to you, but you should not be getting an exemption on the transfer of an intergenerational transfer of that wealth when you die.
If we want to move to a proper pension system, we must focus the tax efficiency of the pension system on the payment of pensions and stop rewarding the savings and wealth lobby with pension tax incentives.
Well said.
Shock – PLSA aligned with thinking of ABI!
The ABI is the trade body for the insurers for goodness sake!
Can we stop attributing some sort of misled benevolence or social motive to it.
Its job is to make money for insurers. Every penny of profit that goes to insurers bonuses does not go to a member’s pension.
We need to stop running our pension system at the behest of “the industry”. The number of intermediaries extracting a rent from Trustees and now DC savers is mindblowingly staggering (as evidence by the over 100 awards at a recent industry awards dinner).
The PLSA should be supporting trustees in preparing them for dealing with all of the intermediaries, to best limit the rent extraction, and to maximise value and outcomes for members, and it should be fiercely independent of “the industry”. Perhaps a Labour Govt will insist it becomes more member focused with greater collective (ie Union) input in its thinking and policies?
I’d love to go to a session on disintermediation run by you , Byron Mckebee, Keating, Clacher and Pension Oldie.
Here here to that, Jnamdoc. Courses teaching trustees how to control the cost of intermediation would be popular – but who would run them!
Ah- ha, I see the next comment is from Pension Oldie – he knows a thing or two! I reckon the regular commentators on this blog including Keating, Clacher, yourself, Oldiew
Perhaps we should adopt the slogan:
“Pensions are for life – ISAs are for savings!”
Thanks Bryn, the IFS are just round the corner from your shop. Why don’t you run a DB teach-in as part of this grand project of theirs?
Making something simpler is often complicated work. Numerous attempts to improve financial literacy haven’t equaled a higher savings rate. Efforts to make tax less onerous often make them harder to understand.
Have you noticed that proposed pension changes are predomiently made by those with inadequate pension provision or to serve the collective mediocraty of large institutions that fail to preserve buyng power.
Whatever happened to innovation?
Is the pension itself tax free to the retiree? In the states, we call that Roth, funded with after-tax contributions, held for five years and distributed after reaching age 59 1/2. If so, why should the assets become taxable to the beneficiary? If the assets are taxable to the retiree, they should be taxable on the same basis to the beneficiary. However, for estate tax purposes, the assets should be treated the same as any other asset.
From the states, I probably don’t understand the tax treatment.
You ask who and what:
Who – Me, the owner of the benefit/investment, the person who deferred consumption and saved.
What – Whatever I deem best.
1) In the states, if I invest in equities, achieve gains, and pass the securities in kind upon death, they get a step-up basis (tax-free on gains during my life). What’s the public policy justifying that dollop of tax preference?
2) However, if make tax-deferred contributions to our 401k savings system, then pass assets at death to a non-spouse beneficiary, they are subject to income taxes. After 2019, distributions must occur within 10 years.
So, the cost of the tax deferral (public policy) isn’t much different (perhaps slightly longer delayed) if I fail to spend it all while I am alive. And, given that most Americans die in their 70’s and 80’s, the beneficiary is often in their 50’s and 60’s where the monies are taxed at the beneficiary’s highest marginal tax rate (on top of their own income) – potentially higher than the retiree’s tax rate.
3) OK, so, assuming I take my retirement savings out of my accounts starting at age 59 1/2, pay the taxes, make equity investments which increase in value (as in #1) then pass them (with untaxed earnings using the step up basis) to my adult children (or grandchildren, or great great grandchildren). Something wrong with that compared to #2?
Nothing wrong with failing to spend all that I saved, leaving it to my designated beneficiaries. Who should benefit when I have possessions at death – like a house, a car, a retirement account?
In the states, what is wrong are changes that enable greater pre-retirement withdrawals (including numerous new provisions added in 2022) – adding more liquidity options for assets in tax-favored retirement savings plans … where payouts become leakage and are not available for retirement.
The #1 fear regarding retirement in many polls in the states is running out of money before running out of time.
Hi Jack, thanks for this and other posts. The leakage that stops people getting fair value by way of guaranteed income so exasperated the UK CFO that he stood up in parliament and announced that “from this day forward , nobody would ever have to buy an annuity again!”
This gave an opportunity to consider retirement saving as “wealth” rather than income.
The weird thing is that over here, withdrawals from pension pots – even cash outs – are seen as “taxable” while bequests made to the estate or named beneficiaries are tax free.
Savers get tax relief on contributions and mostly tax-free growth on their investments so paying tax on the way out is generally seen as reasonable, especially as aa quarter of the pot can be drawn down “tax-free”.
DC pensions in the UK are a bit of a misnoma,
Jack, in US terms the DC pension is more like a Trad IRA （EET) than the Roth (TEE). The closest vehicle to the Roth is the ISA, except that is a savings vehicle, not targeted at retirement, so has no age restrictions on withdrawal.
It’s really the treatment on death that makes no sense, the assets in the DC pension are not included in the member’s estate for IHT (UK equivalent of estate tax) purposes. And whether the ultimate beneficiary is taxed on benefits paid after death depends on age of the member at death (benefits can be tax free).
So there is some incentive to spend non pension savings first to minimise IHT, which is at a flat rate of 40% above the nil rate band, at least for people who have been able to amass meaningful amounts in different savings vehicles.
Your other point on more liquidity options causing issues is also relevant in the Uk. Until fairly recently most people had to use the accumulated DC pension funds to buy an annuity. This dealt with the time/money mismatch, in that the annuity would be payable at the agreed level until death. But they were perceived as being very poor value. And indexation and spouse pensions were options which not all members were willing to pay for (they reduce the at retirement £ value of the annuity paid out). Since 2015 people can take benefits as lump sums or regular withdrawals from the DC pot, but with the greater risk that they will take too much too soon and run out of money (or indeed draw too little because of the fear of running out). Neither of those outcomes are optimal, and it’s very difficult for individuals to work out what’s best. Hence Henry’s wish for some form of collective decumulation mechanism to allow risk to be pooled!