MoneyWeek invited five experts to dinner and asked for their thoughts on the likely outcome of the Government’s pensions ‘A-Day’, when a whole raft of changes to the ways we save are set to come in
Annunziata Rees-Mogg: Pensions have hardly been out of the news recently and for good reason. The current system appears to be a complete mess and there is still some confusion about what happens next year when a whole raft of changes are set to come in on ‘A-Day’, 6 April 2006. What are your thoughts?
James Brooke: The problem here is that the vast majority of the regulations are still in draft format we don’t know which of the supposed regulation changes are actually going to get through and which aren’t. For example, under the proposed changes, residential property will be allowed to be placed in a pension for the first time. But will it really happen? The Chancellor appears to have woken up to the fact that if, as some have predicted, £6bn worth of residential property goes into pensions, he will lose £4bn in tax revenue he will be giving tax relief on the money used to buy the property in the first place and giving tax relief on the rental income that the pension fund subsequently receives. Creating a £4bn hole was not the idea of the A-Day changes.
Robin Algar: I don’t think the £4bn hole will appear. The fact is that if you are going to invest in property in a pension, you are probably better off doing it now rather than later. Right now you may be able to invest only in commercial property, but you can at least borrow an amount equivalent to 75% of the value of the property you wanted to buy. So if you had £30,000 in your pension fund, you could buy a house for £120,000. After A-Day, you will only be able to borrow 50% of the value of your pension fund. So if you had £30,000 in your fund, you could then borrow only another £15,000, leaving you £45,000 to spend on a property. It just doesn’t offer enough leverage for it to end up as big an issue as it is made out to be.
John White: It’s not really going to involve that many people though, anyway? People with big pension pots could use it that’s not enough people to make such a big difference to the property market. Also, the impact will be lessened by the fact that property prices are being deflated anyway, making them far from the most attractive pension investment out there. The other thing, of course, is all the talk about buying foreign properties for pensions. But can most administrators of self-investment pension funds actually cope with buying in Croatia, Bulgaria and Turkey? Doing it in France is going to be hard enough.
JB: Particularly as a number of those countries don¹t even recognise the kind of trust arrangements that are required by self-invested personal pensions (Sipps).
RA: I think it’s important to remember at this point that a pension is just a wrapper, a way of investing in something. This means that the underlying asset, the investment, has got to stand up on its own merits. So when you are talking about property, you have to look at whether this is a good time to be investing in residential property at all. I would wait until the market falls.
Tim Price: But to be fair, pension investments are long-term investments. So it may not be a prudent time now, but we are looking at something that might theoretically have a ten, 15, 20-year reward line.
JB: I think the other thing to remember about pensions is that they are not a tax-elimination wrapper for your investments. Instead, they are a tax-deferral wrapper. You might get tax back when you put your assets in a pension, but when you take income out on retirement you have to pay tax on it then. I’ve compared how you fare financially if you have a pension, buy an annuity and live off that, or if you never put money in a pension at all but invest normallyIt isn’t encouraging: in order to do better with a pension and annuity, I calculate that you needed to live past 110. Now given that most of us aren’t going to, this begs the question why anybody would be putting their money in pensions in the first place. Particularly when you can get the same kind of tax relief from investments such as Enterprise Zone Property Trusts, Bench Capital Trusts and a whole host of other instruments which don’t end up locking you into a pension regime. Our calculations suggest that you are better off staying out of the regime as long as possible if, once A-Day arrives, at the last minute before you retire it looks better to be in the pension wrapper than not, you can still transfer up to the statutory lifetime allowance £1.5m for the tax year 2006/2007 and get tax relief on the whole lot. I would rather keep my powder dry knowing that I have the option of going into the pension regime later than put myself in it now and lock myself in.
ARM: Is it that fear of being locked in that is stopping so many of ubuying into pensions?
RA: I don’t think people are educated on the need to save sufficiently. Advisers educate people about the dangers of not saving and show them the risks. But a lot of people don’t take advice and don¹t really think about it by the time they realise they need to, they haven’t saved enough and it’s often too late.
TP: At the risk of being contentious, I would suggest that the failure to save is in part a reflection of the fact that so many people have been so poorly treated by financial services providers. I read an article in the FT a few months back by their personal finance correspondent. She had been in the job for more than 20 years, but said that if she came into £1m tomorrow, she would put the money into property and international savings products that'[s a pretty damning indictment of the financial services industry here.
JB: Another thing to bear in mind is that there is a whole group of people who don’t save and who are doing the right thing by not saving people in debt. Their first priority should be clearing their debts. Saving comes second. It is also very hard to advise somebody who is maybe aged 20 or 30, because who knows what the situation is going to be 30 or 40 years down the line. Clearly, it will be very different.
RA: I think the most important thing about A-Day is that people should seek advice now. First of all, as to whether or not they are going to be affected by it, and secondly about whether there is anything they need to do in preparation. It’s mainly going to affect people who have got pensions already, who have already saved it’s not really going to affect people who haven’t yet started to save.
JB: It’s also going to affect people who may only have relatively modest and when I say relatively modest I mean £20,000 to £50,000 pension pots as well as those who are already at, or heading towards, the statutory lifetime maximum pension allowance of £1.5m maximum. This statutory lifetime allowance will go up in steps at an average of just under 4% a year. If we assume that the Financial Services Authority is right in predicting that assets within pension funds will grow at 7% a year, it won¹t take very long for somebody who appears to have a relatively modest pension fund today to be knocking on the door of the statutory lifetime allowance, or exceeding it.
RA: There are certain individuals who could do something quite interestingFor example, anybody who is going to retire in the next five years, as well as anybody who is going to retire before next April, should seek advice to find out how they can maximise their benefit. It is also worth noting that one thing in particular that has put people off investing in pensions that they have to purchase an annuity at 65 will be changing on A Day. Anybody nearing age 75 really should take good advice.
Robin McKrill: I¹m a big supporter of A-Day, I think a lot of the changes will be very bold. Other recent changes mean that there are now great opportunities to get involved in the whole process. You can go online and set up electronic Sipps directly and directly control your investments. I do this myself and I find I am much more interested in what’s happening to it than I was before. We’ve touched on the point of education. I think the main danger here at the moment is hype on the property side people think they understand property, but it¹s not as solid as they think. And property alone doesn’t make a pension.
RA: I’m still not sure that this kind of encouragement alone is going to make people save for their pensions. I think the only really effective way to make people save enough for their retirement is by making it compulsory, as they have done in Australia. It seems to be working quite successfully there. If you give people the choice, a large proportion of people will always go and spend their money rather than save it.
JB: But there are huge problems with the Australian system. Because the government doesn’t have to encourage anyone to save anymore, taxes on pensions have soared, for example. They now have what is known as a TTT system: taxed when it goes in, taxed while it’s in there, and taxed when it comes out. I don’t wish to go to that from our current set up of exempt when it goes in, reasonably exempt while it’s in the pension, and only taxed fully when it is redeemed.
RA: Tax is a side issue. What I am talking about is saving for retirementPeople assume they will definitely get their state pension. They might notState pensions only come from taxing the working population and by the time we are retired the proportion of workers is going to be significantly smaller than it is now. That means the next generation is going to have to be taxed an awful lot more than at present.
ARM: But surely the proposed changes to what people can invest their pensions in will make a huge difference, in that it makes saving much more attractive?
TP: I think the opening up of investment options in the way proposed is a good thing. From April 2006, when people see they can put their money in investments such as art and wine as well as shares, pensions are going to look a lot more exciting. And that should mean that a lot of people are going to end up much more involved in their own financial planning. Adding more choice, not more compulsion, is the way forward.
JB: You’ve even going to be able to buy things like fishing boats I don’t know why you’d want to, but you could. We’ve already discussed e-Sipps, which allow investors a hands-on approach to their pensions. Subject to no rule changes in the A-Day proposals, and the draft rules becoming the actual situation, there will be practically no limit to what you can invest in.
That said, as there are already so many ways of being involved, I’m not sure A Day will bring more people in. There are only three things that matter with a pension how much you put in, what investment return you get, and how long it is in there for. Since time is finite we have no control over the age that we are now or when we are going to die that’s fixed. So the only two things we can affect are what investment return we get and how much we put into our pots. And you can’t always control that look at the way Gordon Brown took £5bn a year from pensions by adding a new tax on dividends.
ARM: Can he undo that?
JB: No. Brown can’t afford it. If you look at public spending and the number of public employees and bear in mind that all of us in the private sector are paying for those public-sector employees the situation has gone from good to bad to absolutely disastrous. And the more people who live off other people’s labour by that I mean the more public sector employees living off private-sector workers the worse it will get.
TP: But if it’s bad here, it’s even worse in Europe.
JB: True. We have more in funded pension schemes than the whole of the rest of Europe put together. That’s one very good reason for not getting into the euro and not getting into this federalist state that France and Germany would like to see created. If we did, then they¹d control the tax situation and use us to prop up their own systems.
RM: Being better than Europe isn’t good enough. Something has to be done to encourage more saving for old age. The whole country has been bamboozled by pensions for too long. To me, the crucial question concerns who takes responsibility for investment. Is it you, your employer or the government? A pension is just an investment inside a tax wrapper. You should look after it and make sure it’s going to grow. It should be simple and easy to understand. But it isn’t. It’s complicated and people switch off they can’t cope.
JB: They should try harder. At some stage in life, people will want to be able to choose what they do with their time, rather than sell their time for money. Pensions are just one of many ways of getting yourself to a situation where you are financially independent, which I believe is what everybody wants to do to choose what they do with their time rather than having to work because they need the money. We should replace the word pension with ‘financial independence’, or ‘freedom’.
TP: Or just ‘wealth’.We don’t save our money in pensions because ‘pensions’ is a horrible word. It conjures up the visual image of a pensioner. If you wanted to change the name to let’s call it ‘financial independence’ I think you would get people a lot more interested. If it was viewed as a tool for choosing independence, or for wealth creation and not as something simply associated with old age and lack of money, then I think you would animate everyone’s interest. It seems to be partly an image thing for those people who are spending more than they currently earn they don¹t see the point in making that long-term contribution.
JB: I agree, the association between pensions and being old and poor is the problem. If we could associate the word pensions with being free of having to work, then it would be a whole different ball game. I’m sure we all know people who are over the state retirement age and are still working. People don’t retire by age they retire by income. When you can’t afford to live on what the state gives you, you have to go on working, however old you are.
RM: I don’t think just changing the name is going to do much I think you’re underestimating most people’s intelligence. There has got to be more done than a marketing gimmick.
JW: A pension is a pension, that’s true. It’s been that for donkey’s years and it always will be. The image we’re trying to convey has to do with why you should think carefully about pensions and many other types of investments at the same time. The motivation for doing so is to achieve financial independence.
Still, it does need to sound more appealing. It was noticeable that the first things we discussed were property and pensions rights. Whether or not you think investing in residential property right now is a good idea, at least it has created a massive talking point. People who had never thought about starting a pension are now thinking what they can do with these new provisions can I buy my boat with my pension money? Now whether or not they would buy that boat, it’s nevertheless created an interest among high net-worth individuals. At least pensions are starting to become somewhat more of a sexy industry.
RA: I think that high net-worth individuals have always been interested in how quickly they can achieve financial independence.
JW: Yes, but pensions have never been the thing that turned them on.
RA: But pensions are really about tax, they don¹t need to turn people onPeople don’t need to know about them themselves because they can take advice from somebody who does know.
There are two roles for an adviser. One is to advise someone where to invest their money to get a decent return on their investments, and the other is to consider all the things those investments will be affected by, including tax, charges and everything else. And, of course, looking at all those factors and asking, ‘Is a pension the best thing for you, or should you be putting your money somewhere else?’ Advisers are there to spot opportunities a company director, for example, in certain (rare) circumstances, could put a lump sum into a pension and take it out the next day free of tax.
ARM: James, you’ve said that pensions don’t work for everyone in purely financial terms. But would you still advise us to have them?
JB: Don’t forget that investing via a pension gives you things you can’t get by way of other investments; namely, discipline and security. Once you’ve put the money in there, you can’t get it back, so, unlike with an Isa or savings account, you have discipline. For most people, that is the only real reason why you should have a pension over other forms of savings.
JW: Unless you get offered an employer contribution; you should take advantage of that. There is an argument to be made for moving towards some kind of matching principle. Employers wouldn’t necessarily have to put in the same amount as employees maybe just a proportion and only at certain salary thresholds around the lower level, because otherwise it would just get too expensive. But matching is a major benefit.
TP: But the one thing we do know from the example of continental Europe is that the more expensive you make it for a business to hire by using schemes like this, the more difficult it is to create jobs.
RA: And any kind of compulsion, such as making employers contribute, is really just another tax.
TP: Compulsion is a difficult area, but unfortunately there is a compensation culture at work in our society. I¹m all for having the independence to choose how to invest and save, but with that freedom comes responsibility. Where it breaks down is where people basically fritter it away on God knows what and then expect someone else to pick up the pieces.
JW: People have to be encouraged to take responsibility for their own futures. My vote would be to clean up the state pension and get rid of pension credits; there has to be a carrot for saving, not a deterrent. Whether or not you regard it as a necessary evil, a form of compulsion to do with some kind of matching does, I think, have to come in.
JB: I’m not against compulsion in itself. I’m just concerned that we will end up with tax, tax, tax. Because a government sees that money in there, they’ll hit it as Gordon Brown has already done.
RA: I think that pension planning has to go hand in hand with the more responsible approach from government and the financial institutions towards credit. We have this culture where if you want something you don’t actually have to be able to afford it you can just put it on your credit card. Why should you put money away for tomorrow, when you can borrow today? Some people will borrow and some people won’t. Some people go into debt and some people will save.
TP: And some people become rich and some people don’t.