How do pensions fit into the retirement landscape? Neil MacGillivray addressed the subject at the Money Marketing Retirement Summit. He is Technical Support Manager at James Hay, part of Nucleus the Financial Platforms group.
How likely is the government to remove or reduce tax relief for pensions due to worsening economic conditions?
Chancellors are notorious for tinkering with pension tax legislation, and we’ve seen plenty of previous examples. In our view, there are two reasons for this, first is a general lack of public understanding of pensions law, and second, many of the damaging changes only affect very small minorities – although sometimes noisy. For the vast majority of retirement savers, there is little or no detrimental impact on their own situation, and therefore they do not care about what might be called “stealth taxes”.
For several years, there have been suggestions to review the tax breaks on pensions. However, whenever we have analyzed this in the past, we have always come to the conclusion that it will lead to further complications and misunderstandings.
Looking at the Office for National Statistics figure on the cost of pension tax relief for 2019/20, just under 18% of the total £41,800m cost is attributable to tax relief real for personal pensions, and 4.8% for personal contributions – with the balance being made up of employers’ contributions. Compare these figures with occupational schemes, where employer contributions alone account for around 50.5% of the total cost, with an additional 12.9% for employee contributions. Simply targeting individuals’ personal pension contributions would be unfair and only make a small dent in the overall cost.
I would also say that a significant portion of the tax breaks from occupational schemes are attributable to public sector pensions, and I can’t imagine any government being comfortable with the fallout if it changed the structure of the tax breaks – by especially given the recent success of the fire and justice systems in overcoming the imposed changes.
Can advisors do anything to help protect clients’ savings against inflation?
Regular portfolio reviews are essential, rebalancing accordingly and of course minimizing cash holdings when interest rates are negligible are the obvious steps. There is also a case of managing a client’s expectations of what sustainable income is. There are so many unknowns in the equation such as future returns, longevity and of course the current big problem of inflation. A conservative approach to the amount of revenue taken would be the best advice, but a client may have different ideas.
What is the specific role of pensions in retirement planning now?
While there has been much talk of the ‘race to the top’, the reality for many is that finances continue to be an issue – especially with the current cost of living crisis. It will be too easy for people to view retirement savings as a luxury. However, the commitment to save regularly is essential for people’s future retirement planning. The advantage of saving in a pension, compared to other forms of savings, at least for the moment, are the various tax breaks. For withholding relief schemes, there is an immediate increase in value through the addition of basic tax relief to the contribution, so that a net contribution of £10,000 is increased to 12 £500.
Ignoring any growth issues or Lifetime Allowance (LTA), an individual could take 25% of this as a pension start lump sum, so it could be argued that the actual cost to the individual of Investing the £10,000 is just £6,875 – and that’s without taking into account any higher or additional tariff relief and possible future growth.
What role do Lisas and Isas currently play in retirement planning?
LISAs play an important role in retirement planning. From a tax perspective, anyone under 50, who is only a basic rate taxpayer and probably cannot afford to contribute more than £4,000 a year is the big winner. However, once they reach 50 and the loss of the 25% bonus kicks in, they better set up a personal pension.
In most other circumstances, a pension will be the best option for saving for retirement. When individuals exceed their annual allowance or approach the lifetime allowance, an Isa becomes the best thing to do.
For those who are retired, the flexibility of being able to draw income from different tax packages allows for maximum tax planning and capital preservation, especially since a client also has potential IHT liabilities. For example, a pensioner in bad health and whose life expectancy is limited can draw more income from his Isa than from his pension if he has an IHT liability at death.
What’s the biggest issue we should be talking about when it comes to retirement planning, but aren’t?
Unequal tax treatment between defined benefit plans and other defined contribution plans, with the former enjoying significant advantages over the latter. While some would argue that pension freedoms create a more level playing field, I would argue that these disparities need to be addressed.
Naturally, I understand that this is controversial, but for my part, I believe that the use of an individual’s LTA to pay for DB plan benefits needs to be addressed. An individual in a DB arrangement takes no personal investment risk, and yet the way the benefit payment is calculated against the LTA is incredibly generous, not to mention the fact that the future inflation protection of their income carries no LTA risk.
Contrast this with money purchase arrangements where the individual bears all the investment risk and on benefit payment, if they were trying to replicate those of a DB scheme by purchasing an annuity, they would have the chance to reach half the starting income level of a DB arrangement for the same amount of LTA usage. This is grossly unfair and needs to be resolved at the earliest.