Pensions: more change, please!

As someone who advises individuals on their pensions for RSM UK, I groan whenever the chancellor decides to change an aspect of the pensions legislation; it seems to be that the goal posts move every year. Despite this, I think more change is required.

To understand why, we need a quick history lesson. In 2006 the government introduced a major overhaul of the pensions regime, and this was long overdue.  It was labelled “Pensions Simplification” and it streamlined the pension system significantly. In addition, it introduced the concepts of the annual allowance (the AA). This alluded to an amount that could be saved annually, which benefited from tax relief and the lifetime allowance (LTA), the value by which the funds could grow without incurring a penalty.

The landscape was fairly stable until 2010.  In 2010 the retirement age was increased.  In 2011 the AA was reduced, and changes were made to annuity purchases.  2012 saw the LTA being reduced as well.  In 2014 there were alterations to the number of lump sums available. In 2015, pensions flexibility came in, which was a significant change to many aspects of how individuals can access their pensions. In 2016 we got a chance to draw breath, but, in 2017, it was all change again with a new overseas transfer charge.

In addition to these larger changes, the LTA has been reduced annually between 2012/13 and 2017/18, spawning various fixed protection options along the way.

Clearly, pensions are a favourite topic for chancellors to tinker with and, to be fair, some of the changes were required and pensioners are better off for them.  However, stability is important when it comes to making decisions about long term financial matters. In recent years this has been sorely lacking.

As much as I hate to say it, further change is required to make the pension rules fit for purpose. The single most important move the chancellor could take to improve matters would be to abolish the LTA altogether.

The LTA was a misconceived area of the pensions legislation from when it was first introduced along with the changes in 2006.  However, at that time, the LTA was £1.5m and the AA was £215,000. It doesn’t take a genius to work out that seven years of making maximum contributions will blow the LTA, but the general feeling was that the LTA was set at a sensible level, in respect of pension provision. I In any case, the expectation in 2006 was that both the AA and the LTA would rise annually.

The AA rose until it had reached £255,000 in 2010/11. But in 2011/12, it was slashed. The AA dropped to £50,000. Now, it is even lower at £40,000, and further restricted to £10,000 for higher earners.

The LTA rose and reached £1.8m by 2010/11. It, too, was reduced in 2011/12 to £1.5m, and then reduced over the years to 2016/17 when it reached the low point of £1m.

Of course, most people would say they cannot even fathom the idea of having a £1m pension, so why all the fuss? One answer to this is “compound growth”.  If investments grow at 5% a year, their value will quadruple in under 30 years. So, over a lifetime, even relatively modest annual pension contributions risk exceeding the LTA. Remember that, since 2012, we have had auto-enrolment, and this is now extended to almost all companies – and thus most employees.

Simply put, now that auto-enrolment exists, the likelihood is that more people will start saving for their pensions from a much younger age than was the case previously, and pension pots will grow much larger.

Moreover, a pot of £1m does not actually get you a huge retirement income. Using the generally accepted formula of taking 4% per annum (which provides a reasonable prospect of preserving the fund), you would only receive £40,000 each year before tax. Certainly, this is not enough to let you live a luxurious lifestyle, and, for a middle-class professional, would represent a substantial drop in annual income.

Whilst there was some relief felt in the fact that the LTA was increased to £1,035,000 in April of this year, I do not believe the chancellor has gone far enough.

There is no good reason for restricting the amount to which the pot can grow, especially when it is impossible to predict which stocks are going to grow exponentially. Who would have anticipated that $1,000 invested in Amazon stock at its float in 1997 would be worth around $240,000 20 years later?

Combined with the much-reduced AA, there is no fear that wealthy individuals can benefit disproportionately. If pension pots grow well, the government gets the tax revenue when the funds are taken out to spend.

So, it is best to let people have true pensions flexibility, with the ability to invest as desired, and to get rid of the LTA.