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David Pugh

Lemonade

Managing Partner

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It’s time the Chancellor stops meddling in pensions

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Talk to anyone about pensions and you’re likely to be met with a head shake and a response of ‘I can’t keep track of it’.

Those within the industry are struggling to cope with the recent pension freedom reforms and the Chancellor has signalled he is keen to implement more ‘radical changes’ such as removing upfront tax breaks. If the pension sector cannot keep abreast of things, how can others, such as HR professionals, be expected to respond to employees’ concerns?

If I was Chancellor for the day, I would be radical and stop meddling in pension provision, consider the age-related issues and help businesses encourage employees to save.

Constant Government policy changes do not work; they confuse everyone and coupled with spiralling housing and education costs, have created a huge divide. So what are the key contributors and who are the winners and losers?

Baby boomers ( born post war – early 60s)

Winners – recipients of final salary schemes with guaranteed index-linked pensions. Since April this year, over 55s have three options; take their pension in cash and spend as they wish, invest the money and use a draw-down facility (similar to a bank account) or take a regular income.

Supported by a ‘triple locked’ State pension scheme, the payout either increases in line with inflation, earnings growth or 2.5%. The University of Manchester’s generational expert Paul Redmond says ‘baby boomers will be the last generation to retire with a State pension in its current form’ and the Institute of Fiscal Studies is calling for the ‘triple lock’ protection to be ditched, citing ‘today’s pensioners are better off than any previous generation with average incomes higher than people of working age’.

Baby boomers had to contend with five Pension Acts between 1964 and 1993. The average house price in 1964 was £3,000, rising to £29,700 20 years later. In the mid 80s, house prices were 3.5 times higher than average earnings. There were cheap houses, tax relief on mortgage interest, options to buy your own council house, wealth through massive house price increases and free higher education.

It hasn’t all been plain sailing though; those without final salary schemes converted their ‘nest egg’ into an income for life annuity and there are now concerns over how these were sold. The FCA is reviewing the situation and will report its findings in the first half of 2016 (is this the next PPI scandal?). 

Generation X (born early 60s – early 80s)

Midway in the winners/losers stakes, they benefit from defined contribution schemes (employer and employee pay in), extra top-ups courtesy of Free Standing Additional Voluntary Contributions (remember those), personal pensions and full tax relief. There were options to contract in or out of the State pension schemes – with differing guidelines dependent upon what year it was – and plenty of advice.

Gen X have the new pension freedoms and there may be more options by the time they retire. A new State pension is planned to roll-out from April 2016, paying £151.25 per week for those with 35 years of National Insurance contributions, but this depends on whether you opted out of a second State pension scheme. The IFS says ‘people in their 30s/40s are helping fund current pensioners and are likely to end up on lower retirement incomes’.

Four Pension Acts between 1994 and 2003 – far higher than the five 30 years earlier – the average house price in 1994 was £51,300 and the house price v earnings ratio was 3.4. There were 100% mortgages, easier borrowing and newly-introduced tuition fees (September 1998) were £1000 a year.

Generation Y (born early 80s – early 2000s)

Losers – auto-enrolled into a defined contribution scheme , with few given access to additional pensions advice. Tax free pension contributions for those earning over £150k were slashed in the recent Budget and the Chancellor now has upfront tax relief in his sights, said to cost £40bn a year. The Government is keen to implement a system that’s sustainable and strengthens incentives to save.

Like their Gen X counterparts, retirement income will be lower than now and in order to fund the State pension system, they’re facing a retirement age of 69 by 2040. The IFS confirms ‘young people are unlikely to receive the defined benefit occupational pensions their parents enjoyed and less generous State pensions’.

Pension Acts doubled again, between 2004 and 2014. Gen Y were subjected to 10. They face exorbitant house prices – in 2004 the average was £140,000, 10 years later, £178,000 – and during this period, the house price v earnings ratio veered between 4.9 and 5.0.

Larger deposit requirements and a tighter lending criterion means many won’t buy a property until their 40s and higher rents and student debts means few have savings. In 2006, tuition fees increased to £3000 a year and in 2012, £9000.

How can this generation focus on private pensions with increasing housing costs and debt?

Having assessed the issues, my five priorities in 24 hours would be to:

Make it easier for employees to invest in their employer’s business

This helps them feel part of the business, is motivating and aligns objectives across the organisation.

Make it easy for employees to build up savings

Instead of the hard-to-police Help to Buy ISA, provide a Workplace ISA and take the contribution before the individual receives it. By giving employers a salary sacrifice tax break (as pensions do now), the 13.8% saving could help cover the costs of running the scheme or be shared with employees, providing an incentive to save.

Make it easy for employees to save for their pension

How to make pensions work? Change nothing. People need to be confident that if they lock their money away until 55 they get something in return – namely tax relief on their contributions and a quarter of the fund tax-free. Any future change should be to simplify and remove rules rather than add to them.

Make it easier for employers to support employees’ pensions

Auto-enrolment has been a success as more people are starting to save, however the administrative burden for employers is immense. For many companies the cost of understanding and complying with legislation outweighs its contribution. Much of this complexity can be removed.

Contribution rates will increase in 2017/2018 and these must continue to rise in order for employees to reach an adequate level of income in retirement (around double the current 8% total contribution).

Financial education for all

Financial education only recently became part of the national curriculum so most employees won’t have accessed it as part of their education. Employers should run sessions in their workplace; financial knowledge relieves hardship and helps people realise their aspirations.

Great expectations

There are great expectations on Gen Y and indeed Z (born in this millennium) to financially support the generations that go before them – isn’t it time to give them the tools to do the job?

Financial wellbeing for all can only be assured if the Government keeps things simple and empowers employers to support their staff.

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David Pugh

Managing Partner

Read more from David Pugh
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