The devil is in the detail

Maryrose Fison digs into the detail to see how the recent Budget affected pensions

Last month, Chancellor Alistair Darling delivered his third and last budget before the next general election. With pensions the emotive subject they are, it was hardly surprising to see Mr Darling err on the side of caution in his address to the House of Commons, noticeably refraining from making any major pension reform announcements. But nevertheless, buried in the 220-page budget document are a number of amendments which could have a defining impact on retirement planning for years to come.

Small pension pots

For the first time since coming to power, the Labour party has signalled plans to reconsider the rigid rules which govern personal pensions.

As legislation stands at present, only individuals with money in occupational pensions are allowed to trivially commute their savings to cash if it falls below the threshold amount – 1% of the lifetime allowance (frozen at £1.8 million until 2015/2016). While this has helped those in occupational schemes, individuals with personal pensions have enjoyed no such freedom amid concerns such an allowance would be abused. The fear was that people would set up multiple small pensions as a means of accessing large-scale pension savings which would otherwise have to be annuitised. But, deep in the budget, is an invitation for proposals on simplification, potentially paving the way for thousands of workers to avoid the pitfall of small pension annuitisation.

Scottish Widows head of pension market development Ian Naismith says not only could this help many people in personal pensions, it would also benefit pension providers alike.

“If the government does eventually make this change it could be very beneficial for consumers who get the money upfront instead of as a tiny income and for pension providers who won’t have to write very small annuities, which are loss-making,” he says.

David Higgins, managing director of London-based Re-Financial Planning is in agreement and says such a consultation is long overdue.

“If you take the modern working practice, the idea of going to university and then getting a job for life unless you are a civil servant just doesn’t exist. [The prevailing lack of flexibility] affects an enormous amount of people at all ends of the social spectrum.”

If someone accumulated a personal pension worth £2,000 and then accrued £100,000 in an occupational pension, he says the present rules would go against them.

“The cumulative pension value would be £102,000 – well in excess of the 1% lifetime allowance – meaning you would have to buy an annuity with the £2,000 which is a colossal waste of money.”

Along with opening the doors to consultation on personal pension rules, the chancellor also said the government was open to proposals on couples being able to ‘pool’ small pension pots to achieve a better value by purchasing a joint life annuity.

Default retirement age

With a now overwhelming body of evidence showing life expectancy is increasing, financial advisers are united in their support of the government’s decision to consult on the default retirement age. Presently set at 65, this longstanding and archaic legislation has oft-been criticised as outdated and impractical.

“It is a step forward,” says Almary Green IFA Robert Clarke. “Psychologically a lot of people look at 65 and think: ‘why should I work past that age?’ But, equally, there are a lot of people that get to age 65 and think ‘why should I stop?”

But he warns that any resulting change would have to be calculated so that it didn’t cause a bigger problem for younger workers at the other end of the spectrum.

“The biggest danger is that if those at the older end of the age spectrum are not retiring, it doesn’t free up jobs for those coming in at the younger age.”

Reducing tax relief on high earners’ pension contributions

At the other end of the scale, the government confirmed its plan to restrict tax relief on pension contributions made by people earning £150,000 or more. As the rules stand, individuals earning more than £150,000 will see the amount of tax relief they get tapering off in 2011. For every £1,000 earned above the £150,000 threshold, tax relief on pension contributions will fall by 1%, meaning someone earning £180,000 would see a 30% reduction in tax relief on their pension contributions – getting 20% as opposed to 50% tax relief. The day the chancellor announced the new proposal, anti-forestalling legislation was introduced to prevent people rushing to make large pension contributions but financial advisers have now raised fresh concerns about the practicality of enforcing it.

Almary Green’s Clarke says that instead of hurting high earners, it would simply lead to ever-more intelligent solutions.

“The government is being incredibly naïve to think it will raise as much tax as they think it will do,” he says. “Their calculations seem to be based on the assumption that those caught by the change will carry on paying. But people earning that amount of money can afford to pay advisers and accountants to find ways around it and more suitable investments. I just don’t believe their figures stack up”.

Keith Sheehan, consultant at London-based Timothy James & Partners echoes Clarke’s sentiments adding that the area of alternative investments was already becoming a haven for money that would have otherwise faced punitive tax measures.

“People are looking at other investments which have better liquidity, and venture capital trusts are one of those things,” he says.

“Imagine you are someone who is running their own company. In the past few months things have been very tough. You’ve needed to get your hands on the money. Can you do that from a pension? Not very easily at all. So people are saying, why don’t I put it in a venture capital trust where I can always sell the shares in the first five years and get the money out even though I have an income tax bill.”

Further doubt has been cast over the worth of the measure, after consultant Towers Watson’s analysis of the government’s Impact Assessment appeared to show the estimated one-off cost of setting up the tax had trebled to £900 million from the £305 million originally forecast.

As well as being impractical, Higgins of Re-Financial Planning says it undermined a message successive governments have been trying to get across. “We’ve always been told we should put our money in pensions and now we are being told we can’t put our money in pensions.”

NEST

While tax restrictions on pension contributions gained an oral mention in the budget, albeit not the outcome many had hoped for, the equally charged area of personal accounts was visibly quiet.

Ample Financial Services managing director Colin Parkin says the refusal of the government to release critical details on the package was not only hindering the work of financial advisers but would result in redundancy for the people it aimed to benefit.

“We would like to have been told what [the government] is planning to do, what kind of charges they are planning to have on them and how [IFAs] are going to advise,” he says. “It is going to lead to unemployment without a shadow of a doubt. We are already talking to clients who are employers, who are saying: ‘we need to cut the workforce by 10%, how can we do that, what should we do, should we ditch this final salary scheme now?’

And with business owners disenchanted with the pension scheme, employees who weren’t made redundant would also bear the cost of the scheme, adds Sheehan of Timothy James & Partners.

“NEST will effectively increase the cost of an employee in the first few years over a period of time up to 3%. I’m of the belief that employers won’t increase salaries so individuals will bear the costs. They are going to lose the salary increase and they are going to have to pay in 4% or 5% themselves…That is effectively salary reduction.”

But Higgins says the impact would be felt doubly by those losing out on means-tested benefits they might otherwise have received.

“It’s concerning because people will be being opted into something which may not actually be beneficial to them.”

Low earners who save nothing into a pension scheme can become eligible for means-tested benefits in retirement but leading pension experts have warned that auto-enrolment into NEST could make the same earners forfeit benefits they would otherwise have received, meaning they would have been better off not saving in the first place.

“These people are obviously doing the right thing by saving but what they are not being told is that saving for the future as the law stands at the moment is pointless,” adds Higgins

“If you have saved £2,000 or £3,000 in income from a private pension which you saved hard to achieve, it means that your means-tested benefits are reduced and therefore it is completely counter-productive because you are being penalised for saving,” he adds.

While it remains unlikely any of the political parties will announce further pensions reforms with an election looming large, the dearth of information on the subject is only serving to heighten debate on pensions to fever pitch. Whichever party is elected to power will have a lot of answering to do come May.