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Leaning Tower of Pisa

Pensions to PISA?

01 October 2015

As the Chancellor considers yet more pension changes, retirement savers should be poised to act.

Pensions have been in a constant state of flux over the last decade. As soon as we get used to one set of rules, there is a set of new measures just around the corner.

And so it has proved this year. While new freedoms for taking money out of a pension have been bedding in, the Chancellor has set about restricting how much can be saved into a pension and tapering the availability of tax relief for top earners.

With George Osborne emboldened by his latest set of reforms, it’s unlikely the pace of change will slow. Increased longevity and the changing nature of pension provision - away from final salary to defined contribution - means a fundamental issue has yet to be resolved; namely how to ensure everyone takes responsibility for their own pension saving.

Whilst the current regime, which offers tax relief at the point of contribution, provides a powerful incentive to save for retirement, much of the working population are still underfunding their pension. As a result, they risk lower living standards in their later years and increase the chances of relying on state provision.

Behaviour therapy

Against this stark backdrop, the Chancellor recently opened a consultation to examine how to strengthen the incentive for people to save into a pension. The consultation closed at the end of September and it is anticipated that announcements will be made in the Autumn Statement on 25 November.

“Most agree that any new system should be simple to understand and sustainable, but also extend the appeal of pension saving to lower earners,” says Ian Price, Divisional Director at St. James’s Place. Figures from HMRC for 2012 show that the top 1% of UK earners claimed 30% of all tax relief, so the consultation will almost certainly look at how to rebalance the odds in favour of those who earn less.

One solution is a flat rate of tax relief, an option that has received public support from major industry players, as well as from Steve Webb, former pensions minister (2010-15). This could be a game-changer for lower earners as it would allow more relief to be given to those that need it most and at, potentially, a lower overall cost to the taxpayer. If presented simply, one single flat rate of tax relief would also have the merit of helping to make the system easier to understand, which must surely be a long-term goal.

“There’s also an opportunity for the government to assess whether reform should include ending the restrictions placed on pension saving, such as the lifetime allowance, which can act to discourage investors and constrain investment decisions,” observes Price.

Leaning towards PISA?

Among the other reforms being considered, perhaps the most radical is the one that the Chancellor referred to in his summer budget. “Pensions could be taxed like ISAs,” he said. “You pay in from taxed income and it is tax-free when you take it out. And in between it receives a top-up from the government.”

Changing to an ISA-style system where no tax relief is given up-front but withdrawals are tax-free needs, in Osborne’s own words, “careful and public consideration” before any further steps are taken. Certainly it would bring in some significant tax revenues, but it relies on people buying into the promise of a tax-free income 30 or 40 years hence.

Plan for what you know

Policy experts are divided as to which system we will end up with. Whilst there is uncertainty, many savers will decide the best course of action is to ensure they take advantage of the existing tax breaks available. What can be guaranteed is that, if individuals don’t maximise their pension contributions now, they could lose out on a very valuable opportunity to benefit in the future.

“We could, of course, end up with no change,” says Price. “But, having launched a consultation that raises the prospect of radical reform, it’s unlikely the Chancellor will decide to stick with exactly the same regime we have today.”

The levels and bases of taxation and reliefs from taxation can change at any time and are generally dependent on individual circumstances. The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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