Despite the success of Auto-enrolment in encouraging pension savings, consumer engagement with pensions as a whole remains poor and there are still aspects of the industry that look ripe for reform.
Complexity remains a major draw-back of the current pensions’ system. Despite the much-heralded era of Pensions Simplification begun in 2006, the industry is still mind-bogglingly complex for a non-expert. 2017 research by B&CE found that 74% of working-age people with a pension don’t understand the concept of tax relief on pensions.
Can they then really be expected to understand terms such as ‘contracted in and out’, ‘carry back/forward’ or ‘lifetime allowances?’,
Tinkering is clearly an issue. While pensions have been largely left alone in the past two budgets, this comes after a period when almost every previous budget saw major changes to the pension rules. It is easy to see that millennials, for example, might have difficulty with a long term savings product which is subject to changes surrounding when and how they can take their income.
At the other end of the spectrum, there are many pension savers who now find that they are in breach of the Lifetime Allowance (“LTA”). Perversely, the LTA has been successively reduced by Chancellors from £1.8m in 2012 to £1.03m in the current tax year – in a naked attempt to save on the tax relief given – in spite of the fact that, with gilt rates at record lows, a capital sum buys less and less pension income in the annuity market. Any surplus over the LTA drawn down from a pension attracts a punitive potential 55% tax rate. So, yet another disincentive to save hard into a pension scheme.
The final problem is the dearth of advice available. The combination of increasing regulation and pensions mis-selling scandals have caused large numbers of advisers either to withdraw from the market for pensions advice or to apply such a large minimum fee as to render it unaffordable or unviable for those with smaller pots. Anyone with a pot of more than £30,000 is obliged to take independent advice. This threshold should be raised to £50,000 immediately.
Auto-enrolment is clearly making a difference. The number of employees contributing to a pension has risen by nearly 80% from 2011/12 to 2015/16. In 2017, 73% of employees were contributing to a company pension scheme . For the time being at least, opt-out rates have been low.
For many however, pensions are just too complex to grapple with as they progress through their working life. Projections by the DWP suggest that the average person will have 11 employers over their working lives. Today’s 18-34 year olds are far more likely to have had multiple jobs. Around one in five people admit they have lost track of a pension. If people are not engaged with their pensions, some of the good work of auto-enrolment may be undone.
SIPPs have offered greater clarity and control by enabling investors to consolidate qualifying personal and occupational schemes into one pot. They offer flexibility to increase, decrease or cease contributions easily in the build-up stage and total freedom as to drawdown. They also offer excellent tax-planning opportunities as regards IHT.
Without the apparatus of employee-sponsorship, it is clear that pensions have diminishing appeal. The number of self-employed saving for a pension has dropped from 500,000 in the tax year 2011/12 to 350,000 today.
This would be fine if ISAs were picking up the slack. They remain a popular product and well-used for long-term savings. However, around 80% of ISAs remain in cash, rather than stocks and shares and as such, may not be growing fast enough to ensure a comfortable retirement. The Lifetime ISA has some appealing aspects – the 25% government contribution is easier to understand than the complex rules around tax relief – but it still lacks the compelling simplicity of a standard ISA.
Too often the solution of the pensions industry has been to try and scare people into action with dire warnings about the many hundreds of thousands they will need to achieve comfort in their later years. This may well have the opposite effect, making the task of retirement saving look so insurmountable that people are put off trying.
There are no easy solutions. However, current incentives around pensions aren’t working well. Pensions need a facelift for the next generation.
James Johnsen, Church House Investment Management.