Freedom and choice in pensions
Here is my submission to the Treasury in response to the consultation on pension reform launched after the Budget.
Freedom and choice in pensions
Response to consultation
This response principally concerns the need to reform the lifetime allowance system at the same time as dealing with the issues more clearly addressed in the consultation document. I make it in a personal capacity.
1. In his Budget speech on 19 March 2014 the chancellor stated–
We will legislate to remove all remaining tax restrictions on how pensioners have access to their pension pots. Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits.
2. From that I inferred that he intended to remove the lifetime allowance (“LTA”) pension restrictions. I am one among many pensioners affected by these, as was set out in an article in the Financial Times on 15 March (Money section, p. 4), but I looked in vain for mention of the abolition of LTA in the press releases. I therefore contacted HMRC’s Pension Policy unit, and was told that–
There are no plans to review the lifetime allowance tax charge which is part of the Government’s policy of restricting the amount of tax relief that is given for pension savings.
3. Since I am in the position of having an unprotected pot in excess of the FP2014 limit, I find myself at the age of 59 (not as stated in the FT article) obliged (to avoid further 55% tax) to crystallise my pension far earlier than I would otherwise wish to, and I fail to see how the HMRC statement is consistent with the Chancellor’s promise.
4. People in this position with scheme-specific protected lump sums will also be obliged to buy annuities, contrary to the Chancellor’s statement in the same speech that “Let me be clear. No one will have to buy an annuity.”
5. It is to say the least highly unfortunate that these statements by the Chancellor were anything but clear. I urge the Treasury to issue immediate clarification of the issue before the deadline for this consultation as people in my position are faced with difficult choices.
6. These choices have been made even more difficult and more urgent because of the likely effect of the Chancellor’s remarks on the annuity industry (see below): if, as many commentators predict, annuity rates will become even less favourable, the costs of delaying drawdown for people in the position I describe worsens every day.
7. These unfortunate statements are only the latest examples of poor communication with the public over these issues. Many of the problem with LTAs arise (see below) from the complex interaction between defined benefit (“DB”) and defined contribution (“DC”) pensions, and most of the general summaries produced by HMRC and copied by pension administrators and journalists reduce this to an equation of a pension of £75,000 p.a. with the £1.5 million LTA pot.
8. Pensioners who rely on that statement and falsely conclude that they have no LTA issue, and fail therefore to take out protection when they should are in effect the victims of mis-selling. (As the FT article reveals, some 4000 of them have already paid the charge, and there are probably far more already trapped who have not yet reached the events precipitating the charge.) You cannot expect people to read each finance bill from cover to cover, and the claim that this is sufficient notice would not succeed in a consumer contract under the unfair terms regulations. The failure to provide direct notification to pensioners of changes to the system that directly affect them is incomprehensible unless there was a deliberate wish for them to fail to take out protection. It is as though you parked your car legally, and returned to find it towed away with a fresh red line painted over the spot.
9. The removal of HMRC’s discretion to backdate applications for fixed protection is further evidence of an intention to penalise the unwary.
LTA rules and pre-commencement pensions
10. There may or may not be good policy reasons for restricting relief on pensions. If so restrictions would operate far more fairly by limiting relief up front rather than after people have taken complex decisions in good faith. But if LTAs are to remain in place, one aspect that operates with astonishing and unintended unfairness should be reformed. That is the treatment of pre-commencement pensions.
11. To take a simple example, consider the difference today of having commenced an indexed pension of say £45,000 on 5 April 2006 compared with one commenced just one day later. The second pensioner would still be able to convert a DC pot of £600,000 today and escape the LTA charge altogether. But with exactly the same numbers, the first pensioner would face a charge of £150,000 (or £330,000 if taken as a lump sum) when crystallising the same pot.
12. Two reasons contribute to this anomaly which discriminates particularly against more vulnerable pensioners (those who need to draw part of their pensions rather than deferring them). The first is the higher multiplier which was imposed (according to HMRC) because they withdrew tax-free lump sums – or if they didn’t “they had the opportunity to do so.” But if a pensioner didn’t take a tax-free lump sum, perhaps this was because the opportunity wasn’t attractive – in which case why should he suffer this penalty?
13. The second is the application of this multiple not to the level of pension in 2006, but to the level flowing on the subsequent benefit crystallisation event. The concept arguably worked when the allowance was intended to rise each year, but when the LTA was brought down no one remembered to correct the pre-commencement computation. This is a muddle intellectually, and is totally counter-intuitive. I received written advice from a well-regarded IFA that failed to grasp this particular point, which only emerges from an intensive study of the Revenue manuals.
The annuity market
14. The need to reform the annuity industry is not in doubt. I recently received quotes for an index-linked annuity, the best of which was a 35.8 times multiple (i.e. 2.79%). But, while considering my options to mitigate the LTA charge, I was quoted a “cost neutral actuarial factor” to commute such a pension of 18.544 times (few pensioners obtain quotes in this direction, and so have no idea of the scale of the difference). In other words this is an industry with 50% bid–offer spreads. It has been the one financial market with no liquidity or transparency, where large companies always knew what side customers were on.
15. But it could have been cleaned up by the introduction of a secondary market and standardised, tradeable certificates.
16. Instead the Chancellor’s announcement will in effect destroy this industry. As numerous commentators have noted, once annuities cease to be compulsory, insurers will have every motive to worsen the terms for those who do apply. But there may be less obvious results. With their business model wrecked, some of these companies will cease to be undoubted credits, and the current model, where consumers can buy instruments requiring them to take 35 year counterparty credit risk, will break down. The result will be to weaken competition since it will no longer be possible to compare quotes directly.
17. It is also possible that some annuity providers will collapse. In view of the way in which the announcement has been made it is likely that any pensioner who loses money as a result would expect the Government to make good his loss. Equitable Life may have brought its own misfortune upon itself, but the future collapse of annuity providers looks more like Government carelessness.
Postscript – 2 April 2014
I’ve just received a response from the Pension Consultation team, whose attention I drew in particular to paragraph 5 above. They say:
Unfortunately, due to the volume of responses we are receiving, we are unable to respond to each inquiry individually. We will consider your views alongside those received from other respondents and publish a summary of responses once the consultation has closed.
That’ s a no then.