Beware Negative Impact of Pension Changes

BUDGET 2015: Policies may look like a boon to retirement savers - but the devil is in the detail, say experts, and many civil servants and savvy savers will be penalised

Emma Simon 18 March, 2015 | 3:36PM
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This was a Budget aimed squarely at savers, with many of the changes targeted specifically at those saving for their retirement.

There were two key pension changes in the Budget: First up was the confirmation of the news that the lifetime allowance - the maximum amount that can be saved into a pension - would be cut from £1.25 million to £1 million. This allowance will rise in line with inflation from 2018.

More welcome, was the announcement of a ‘second-hand’ annuity market - allowing five million pensioners to cash in these lifetime contracts.

Lifetime Allowance

This isn’t the first time that the Chancellor has cut the lifetime allowance (LTA). When this lifetime allowance was first introduced, in 2006, it was £1.5 million.

The move has been framed by the Treasury as a way of restricting the pension tax relief given to the wealthiest savers. As the average pension pot stands at just over £30,000 this restrictions will only impact a tiny minority of savers.

But many financial experts point out that this gives out a mixed message to savers of far more modest means.

Ros Altmann, a former government adviser on pensions, argues that the Government should introduce a cap on contributions, rather than limit the value of these pension funds.

“This LTA cut is punishing long term investment success, which pensions are supposedly designed to benefit from. It sends out the wrong message to savers,” she said.

Others go further. Malcolm McLean of pension advisers Barnett Waddingham said: “The LTA reduction is unfair, unnecessary and unwise.”

Adrian Walker a pension expert at Old Mutual Wealth adds: “The lifetime allowance should be abolished not reduced.” He said the future indexation of this allowance is ‘scant consolation’.

“Pension contributions are already capped each year which places a limit on the amount an individual can claim in tax relief. The lifetime allowance cap therefore only penalises investment growth.

“Reducing it further is a counter-productive measure that discourages saving and runs contrary to the pension reforms that have taken place over the last year.”

Alan Higham, retirement director for Fidelity Worldwide Investment points out that this reduction will further exacerbate the gulf between private and public sector pension provision.

“Even under the new lower £1 million limit, those with defined benefit pension – primarily those working in the public sector – will be able to earn pensions of up to £50,000 a year.”

But as he points out a pension fund of £1 million will only secure an income of around half this - £26,000 - at today’s annuity rates.

These calculations assumes buying an annuity that pays a spouse’s pension, so putting it on par with the pensions offered in the public sector.

However, he said this lower LTA will hit higher-paid individuals in the public sector.  Civil servants earning more than £77,000 today or £67,000 in future, head-teachers earnings more than £75,000, doctors earnings more than £70,000 or those in the armed forces earning more than £79,000 - which will include Wing Commander, Lt Colonel and Commander ranks and above - are likely to see future pension entitlements squeezed.

Second-Hand Annuities

There was a more cautious welcome for plans to open up the annuity market - otherwise known as ‘the great annuity escape’.

This will enable the five million pensioners who have bought an annuity with their pension saving to benefit from the wide-ranging pension reforms introduced in last year’s Budget. Until now these have provided an income for life, with no option to either sell, or transfer to another annuity provider.

John Fox, director of the pension provider Liberty SIPP said: This will be music to the ears of many pensioners and will serve as a veritable vote-winner for the Chancellor.”

As he pointed out far more people will potential benefit from this giveaway, as will be hit by the reduction to LTA - and what’s more it doesn’t cost the Exchequer a penny.

But he warned: “The devil is in the detail, of course. Forget actuaries, the Chancellor will have to employ the services of Stephen Hawking to come up with a formula for calculating the value of annuities.”

Many financial experts have expressed concerns that if this sector is not regulated carefully enough, it will sow the seeds of the next financial mis-selling scandal.

Steve Groves, chief executive of Partnership, a specialist annuity provider, said this consultation should focus on developing a “well-regulated carefully-designed second hand market’’.

“[These changes] have to have a genuinely positive impact on people’s lives and this needs to be at the heart of the consultation.”

He said this reform should make annuities a more attractive option at retirement - as people know they have the option of selling out, should they need a cash lump sum at short notice.

But there are concerns that many people will not get a ‘fair value’ for these annuities, and some may be tempted to accept a cash-in-hand price that is well below the long-term value of these contracts.

Fox added: “We shouldn’t expect the  annuity companies to offer great value if they are forced to buy their annuities back. Pensioners were punished on the way in and are just as likely to be punished on the way out.”

It is also clear that wider changes to savings contained within the Budget could impact on the pensions market.

The new Help to Buy Isa offers benefits similar to the tax-relief on pensions. For many younger people looking to get on the housing ladder this may make Isas a more attractive options. Similarly many of those in their 30s may favour the increased flexibility offered by the new Isas - which allow them to withdraw funds, without losing this tax-free entitlement - rather than lock money into a pension where access is restricted until the age of 55.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Emma Simon

Emma Simon  is a financial journalist, specialising in investment and consumer issues, writing for Morningstar.co.uk