By Roger Clark, Head of Wealth Management, Brown Shipley
The past few years have seen a series of cuts and reductions, most notably to both the annual allowance and lifetime allowance.
This lack of stability gives the impression that pensions do not have a long term commitment from the government and that savers should expect more changes in the future. This is proving to be counter-productive as some pension savers look to withdraw their pension fund in April before the government changes its mind.
It is quite understandable that in an age of austerity, the UK’s pension tax system remains fair, affordable and sustainable for the future. Indeed, the income tax relief for pension savings is substantial and according to the recent Budget, the cost to the government was around £34.3bn in 2013/14.*
Whilst there has been speculation about further cuts to the annual allowance, for the moment the government restricted its attention to the lifetime allowance, reducing this to £1m from 2016. Uncertainty surrounds the result of the general election in May and what impact this will have on pension policy in the future.
One risk is that the rules will be changed again to pay for different policy objectives. The Labour party has already announced its intention to pay for a reduction in tuition fees by changing pension tax relief. Whilst the Association of British Insurers was supportive of a reform of tax relief, their response was “…this is not the way to do it. We need a focus on reforming the pension tax relief system as a whole to make it fairer, better value and encourage saving from middle earners…”**This is essentially the dilemma faced by the next government – to embrace a significant review and reform of pension tax relief, possibly with political consensus, or to continue with the current system.
What does seem very clear is that pension savers would appreciate a period of stability and certainty to plan for their retirement.
For the vast majority of the UK population, recent changes to the annual allowance and lifetime allowance may seem to have little impact in the short term. High earners will be more concerned about the continued and very significant reduction in their allowances. Next year, the lifetime allowance will have fallen 45% and the annual allowance a staggering 85% from their highest levels. It is clear that many high earners will be forced to supplement restricted pension funds with other sources of savings.
If we ignore the financial constraints imposed by austerity, it seems there will be a reassessment of the purpose of pension tax relief post the election. It could be argued that the current system favours high earners, as they are more likely to save anyway.
Conversely, low earners are less likely to take advantage as they may well require surplus income for living costs and feel they cannot afford to put this into a pension.
The introduction of auto-enrolment and its use of ‘soft compulsion’ has been a significant factor in improving pension savings.
However, if the majority of UK workers will be in a pension fund as a result of auto-enrolment, the purpose of pension tax relief must surely be to encourage people to save more for their retirement.
The new pension rules will allow people to take a more flexible approach to their pensions, allowing them to transition benefits as they stop or reduce employment. The decision for many people will be whether or not to convert their pension fund into a regular income stream for life or access it immediately, to deal with short term financial needs. Whilst annuity purchase could prove the right choice for many retirees, a flexible drawdown plan could become the vehicle of choice in the future. Existing products no longer fit this brave new world and we will see new products coming to the market, many of which are likely to incorporate a combination of annuity, to give income certainty, and drawdown, to take advantage of the new pension freedom.
In later years income generation will remain a concern, but this could be a challenge for many people who are asset rich, but cash poor. They will need to find new ways to release value and it may be that equity release will come to the fore. Currently there are inhibitions about using this product and if it is to realise its potential then this needs to be a well regulated and advised market with appropriate products. For anyone with an existing annuity, the intention is that they will be able to sell this back to the market, thereby releasing capital. However, this will require careful assessment, both in terms of the value received and the tax liability on the sum released.
Amid all the uncertainty related to the financial planning outlook in the post-election world, what is very clear is that the ability to pass on wealth to the next generation will remain incrementally important to voters. The opportunities in which wealth can be passed on more easily could be better secured and balanced by the provision of sufficient lifetime income from pension and other sources.
*Source Budget 2015
**Source ABI website “The ABI responds to Labour Party proposals on pensions tax relief” 27/02/15
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