Philip Hammond has a lot on his plate. As the Autumn Statement approaches, shielding the UK economy from Brexit’s slings and arrows will be higher up his agenda than fiddling with a pensions system which was tinkered with year after year under the last government.
Some of the changes (many at the exit end of pensions) were good ones. Freedoms have liberated the over 55s, and stopped many from having to purchase annuities at a time when rates are so dire. Yet, in many ways, George Osborne left his political football more deflated than when he took office. Take the lifetime allowance (LTA), which caps the total amount an individual can save into their pension tax-free. In just six years the LTA has been slashed successively from £1.8m to £1m, which has caused some 90,000 people to stop saving into a pension altogether. Many of them are public sector workers. Save often, was the government’s message, but not too much.
Encouraging people to save for retirement is as much about what a government talks about and doesn’t do, as the policy it actually implements. Plans to introduce a flat rate of tax relief, or scrap the tax-free lump sum, both of which were mooted but never materialised under Osborne, have eroded the public’s trust in pensions by stoking fears that some future government minister could stage a tax grab decades from now simply if it is politically expedient. Scrapping the LTA entirely would help restore some faith in the pensions system by showing people of all ages that saving is always a good thing.
Save often, was the government’s message, but not too much
Attention should shift away from the exit end and towards increasing saving among young people. Auto-enrolment has been a good start. In July, the Pensions Regulator reported that two thirds of all employees were in an active pension scheme, up from 47 per cent in 2012. Under auto-enrolment, savers never see the money leave their account, and have to expressly opt out, which requires significant effort. Of course, there is a point at which auto-enrolment would stop being so effective because people would begin to feel their wallets getting lighter. This might be reached if contributions rose much beyond the 8 per cent they will in the coming years (5 per cent from the individual and 3 per cent from their employer). But different “nudges” could probably boost pension saving further.
Many young people say that they would save more if they could. When the director of the Chartered Institute for Securities and Investments said in February that a 25 year-old would have to save £800 a month for 40 years to enjoy £30,000 a year in retirement, her grossly simple calculation ignored the fact that people tend to save more in their forties and fifties when earnings tend to peak. Small surprise that cash-strapped twenty-somethings balked at it.
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One solution, touted by former pensions minister Steve Webb, is to copy the Save for Tomorrow scheme which has been very successful in the US. It would encourage people to commit beforehand to saving a greater percentage of their income into a pension as and when they get a pay rise. When a person switches jobs, their P60 would tell their new employer how much they save, so the good work is not undone. This taps into our lack of self control in the present, but good intentions for the future. Hammond would do well to consider it.
But whatever the new government decides to do to pensions, it should undoubtedly be more consultative in its approach. “Freedoms and the secondary annuity market were sprung on pension providers with short implementation times,” says Fidelity’s Richard Parkin, with resources diverted to adapting products to meet the new rules.
Savers must now be allowed to maximise contributions, and providers must be free to maximise their returns.