Is this what Government is saying on pensions?
In times of changing demographics and pressures on tax incentives to be appropriately targeted, where might pension policy take us? Mike Morrison, head of platform technical, AJ Bell writes
On my return from a holiday in sunny Seville the headlines that caught my eye were the thoughts of the pensions minister, Richard Harrington.
A couple of months ago I attended the TUC pensions conference with the main aim of hearing Harrington. I was surprised when he told the audience that, in his view, people needed to save a £250,000 pension pot. This was based on a target pension of 65% of the average salary.
I went away wondering whether this minister knew how difficult it was for many to reach such a limit, particularly considering the rather low average size of current pension pots.
Several weeks later Harrington reiterated this in the trade press:
“At the moment if I just look at the numbers at the base end – the state pension is [just over] £8,000 per year and the average amount people need to retire on, based on 65% of the average salary, is £18,000. That means they have to find another £10,000 per year, so a pot for argument’s sake of £250,000. The government is basically saying you need £250,000 to retire to get your income to the average, and we are prepared to allow you four times that [with the LTA].”
Is this what the Government is saying? Does it know that it is saying this?
Is pension policy really, ‘take the national average earnings figure, subtract an amount for state pension then fund for two thirds of this amount. The maximum you can fund for is four times this amount.’? I have looked hard through various Government documents and cannot find this anywhere.
Don’t get me wrong, this could be a step forwards. Just over two years ago, I wrote an article suggesting something along similar lines:
“For me, the lesson is that the focus should be on the level of income that an individual can target for the future, not the fund value, and for as long as we have a system that is primarily based around annuities it is the annuity conversion that is important. This would involve some sort of target income being set by the legislators, and the point of controversy could well be how much that should be…
“What level would it need to be – National Average Earnings (NAE), 50% of NAE or something else?
“Don’t get me wrong, I would prefer that we did not have the LTA, as an annual allowance should be sufficient. But if we are to have one, let’s make sure it works and encourages people to target their savings accordingly.”
Obviously there is the possibility to save in excess of the LTA in a tax-efficient way using other investment wrappers. Indeed, Harrington confirmed this:
“The implication is that the Government cuts you down and that is all you can save and therefore you can’t possibly make your retirement … [But the LTA limit] doesn’t stop people doing other things [with their money]. With ISAs you can put in up to £20,000. So if you add that through after they are over the £1 million pot, it is not as if it suddenly stops.”
Note the ISA reference at the end – call me paranoid but isn’t it interesting how the ISA limit is going up (and more quickly than before) at the same time as there is a downward pressure on the amount that can go into pensions? ‘ISAs are the solution’ seems to be the underlying message at the moment.
A couple of thoughts:
• The traditional defined benefit (DB) maximum pension was always two thirds of salary – that was, however, the member’s final salary not the National Average Earnings.
• We really need to address the inequity between the LTA for DB pension schemes and the LTA for defined contribution (DC) pension schemes. The LTA for the DC regime is back to an annuity purchase test with a purchase price currently of £1 million. The LTA for the DB regime is based around a 20 times factor, giving a maximum pension of £50,000 p.a. Is the problem that it would be difficult to change? The phrase, ‘turkeys voting for Christmas’ springs to mind!
An interesting addition to this is the FCA acknowledging that the continued reductions to, and tinkering with, the LTA are causing higher earners to invest in higher risk assets. Presumably these are people who have reached the LTA and think it makes sense to take riskier decisions outside the pension. Alternatively, the complexity of the system may be putting people off from funding any further.
I fully appreciate that, for many, a million pound pension pot is a lot of money, but surely it is not wrong to ask how a maximum is calculated. The LTA started at £1.5 million and if it had increased without change it would presumably now stand at around £2 million. Arguably it started from a factual position:
“It is factually accurate that, assuming a 20:1 valuation factor, £1.4 million is broadly equivalent to the maximum pension allowable under the current occupational pensions regime, which includes the earnings cap. That does not mean that such a sum would at any given time necessarily be enough to buy such an income.” (NAO report from March 2004; The Government estimate of the impact of the pension lifetime allowance.)
In times of changing demographics and pressures on tax incentives to be appropriately targeted, any maximum should be reasonable and objective.