Stakeholder pensions are still not perfect.
On 10 January, the government announced most of its decisions about stakeholder pensions, but held back on the tax regime. We got answers on 22 February. They show some progress on the government’s first thoughts, published in September 1999, but they are still not perfect. One of the biggest concerns about the September thoughts was that carry-forward of unused relief, and relating back of contributions to the previous year, would disappear. This would be bad news for the self-employed who often do not know their earnings until after the end of the tax year. The government has decided to keep relating back, but is to end carry-forward. This will hit people who are building up new businesses and want to invest every penny in the early years, intending to catch up on their pension contributions later. Furthermore, carry-forward is being stopped dead from April 2001: anyone with relief brought forward to 2000 will have to use it quickly. The September thoughts included a new five-year rule: if someone stopped work, in calculating maximum contributions for the next five years they’d be able to look back to their earnings when they were working. This would have given odd results: someone whose earnings stopped could make higher contributions than someone who continued to work on reduced earnings. The government has addressed this point. Even if someone stays in work, they can base contributions on the highest of current earnings and earnings in the best of the previous five years. But the draft legislation does something bizarre for people who have stopped work. For the five years following the last year in work, they will be able to use the earnings from the best of the last six years in work – looking back for up to 11 years instead of five. They will still have an advantage over people who stay in work on reduced earnings. Worse still, they will lose this advantage as soon as they go back to work. Someone with spare cash that they want to put into a pension fund could be best advised to avoid work! The new rules will not just apply to stakeholder and personal pensions but to defined contribution occupational schemes (where contributions are fixed and the pension is whatever the fund will buy), if the schemes choose the new rules. This is very good. For too long, defined contribution schemes have been subject to funding rules designed for defined benefit schemes (where the pension depends on salary rather than on contributions). But there is a catch. Some defined contribution schemes are over-funded: they would, if contributions were not reduced in future, break the rules that apply to them at the moment. Once they have switched to the new rules, they will never be caught. So the government wants a power to stop over-funded schemes from switching to new rules. The government may be worrying too much about this. It would be simpler to say any scheme can switch to the new rules by April 2001 with no checks, because it would be difficult to build up serious overfunding by then. After, only schemes for high earners need to be checked. However, we will not know just how much checking the government wants to do until the regulations are published later this year. Sadly, defined benefit schemes are left out on a limb. They will not be allowed into the new rules. That is not surprising: defined benefit schemes are quite unlike any other form of saving. There is no obvious link between the contributions for a given pensioner and the money that pensioner gets out of the scheme. It is therefore easier to limit the pension that comes out than it is to limit the contributions that go in. Having said that, the government will continue to look at ways to allow moderate earners to be in defined benefit schemes and stakeholder or personal pensions at the same time. This is a worthy aim. The more people encouraged to make good private-sector pension provision, the better. The government is worried about the immediate Exchequer cost of people doing too much for their old age. But most people do not have lots of spare cash to put into pension funds, so the cost would hardly jump overnight. – Richard Baron is deputy head of the policy unit at the Institute of Directors.