Stability is essential to solve this tough problemby Paul Feeney / March 23, 2016 / Leave a comment
Britain faces a fundamental question of whether the country is able to sustain the retirement expectations of its growing and ageing population. Plans for retirement may have changed for some—more people are expecting to work later than 65, for instance. But recent research by Old Mutual into retirement income has shown that there is a continued reliance on the state. Three quarters of retirees currently rely on the state pension for a proportion of their retirement income, while of those not yet in retirement, 87 per cent say they will be to some extent dependent on the state pension.
The state pension age of 65 was introduced in 1925, with women’s pension age cut to 60 in 1940. Anyone reaching 65 in 1925 (born in the 1860s) was in the minority. Average life expectancy for a male born in 1925 was still only around 56, and for a female was around 60. At this point therefore, very few people could be expected to reach state pension age, meaning a minimal demand on the state.
Dramatic increases in the average life expectancy throughout the 20th century and the impending retirement of the so-called baby-boomers means the cost of retirement has spiralled. According to the Office for National Statistics, in 2012/13 the basic state pension, second state pension and winter fuel allowance cost a combined £94bn. At that time there were around 12.5m people of state pension age.
Increasing the state pension age will help to tackle the growing expense. From 2020 both men and women’s state pension age will be 66, increasing to 67 between 2026 and 2028 and then linked to life expectancy after that.
Despite this, by 2051, the old-age dependency ratio—the number of people in work relative to those in retirement—is expected to hit 2.9. In 1971 it was as high as 3.6. Therefore fewer British people of working age will be paying a state pensions bill far greater than it is today.
With an ageing population, the state pension Triple Lock (see p6), which ensures that the state pension will increase by the highest of CPI inflation, wage growth, or 2.5 per cent, also looks vulnerable. The Triple Lock aspires to the admirable goal of ensuring financial security in old age. But such an inflexible system of guaranteed uprating means that the cost of the state pension in an ageing society will grow—dramatically so if the economy endures a sustained period of low wage growth and inflation.
When looking at the affordability of the current private pension regime, if you include relief on income tax and National Insurance contributions, through the pension system the government gave up nearly £50bn in 2013-14. The Treasury has taken a number of steps over the last decade to manage that cost. Since 2006, the maximum annual contribution into a pension has fallen from £215,000 to £40,000. From April, those earning £210,000 will only be permitted to save £10,000 before tax breaks are taken away.
Auto enrolment, which compels those in work to save a certain portion of their income into a pension, will bring around nine million extra people into the pensions market. Many of these new pension savers will be basic rate taxpayers eligible for tax relief.
Contribution rates have thus far been set relatively low for fear that workers would otherwise opt-out. In truth, opt-out rates are currently lower than many initially feared and the minimum contribution rate, planned to rise to 8 per cent from April 2019, should be increased rapidly to increase savings. The introduction of auto-enrolment was expected to increase the cost of tax relief, as the government lost tax revenue due to some pension contributions being exempt from tax. But a recent HMRC update showed that the cost of tax relief has not increased vastly since its introduction.
Despite this, the total government revenue lost through tax relief is still significant and while fiscal targets continue to be re-adjusted at every government spending announcement (of which there have been five in the last 16 months!) that bill looks increasingly unaffordable.
Until recently, the government had kept the public, press and industry guessing about its plans for pension tax relief, following the announcement of a consultation last year. However, as speculation grew that the Conservative Party was becoming more divided over Brexit, the chance that the ultimate decision on tax relief would be politically motivated, rather than fiscally, became more likely. But playing with pension policy like a political football does not build trust in long term savings. The introduction of the Lifetime ISA, announced at the Budget for people under 40 to save for a house deposit or their retirement, adds yet another ingredient into the mix.
Constant conjecture about changes to pension tax relief has led to many people funding additional pension contributions ahead of the Budget in anticipation of a cut to tax relief. This is no bad thing, but shows that speculation about future changes has a meaningful impact on behaviour.
In fact, for some people, pension reform has actually put them off. Very recent research undertaken by Old Mutual Wealth with YouGov highlighted that as a result of recent changes to pension policy, 1 in 10 are less likely to start saving into a pension entirely.
“Playing with pension policy like a political football does not build trust in long term savings”
Over the longer-term, the best way to reduce the burden on the state is to encourage long term savings. Increasing the uptake of financial advice will help tackle this by giving people access to professional help on the essentials of basic financial planning, ensuring they build a secure financial plan during their working lives and the resources to enjoy a prosperous retirement.
It is commendable that the government is tackling this through the Financial Advice Market Review.
But of even more importance is that after a period of radical reform in pensions, there is a period of stability. There is no doubt that the introduction of pension freedoms in 2015 did much to educate and enlighten the public as to the benefits of long term savings, but much of that goodwill may have been eroded speculation around continued changes.
Following a tumultuous decade for pensions, the government should commit to no more material changes to pensions tax relief for a generation, enabling all parties, from regulators, providers and customers, to make decisions with confidence that the landscape will not shift as fundamentally as it has in recent times.
Paul Feeney is the Chief Executive of Old Mutual Wealth