By Alan Mellor, Managing Director and Chartered Financial Planner at Phillip Bates & Co Financial Services
This week saw a report from the Office for Budget Responsibility warning that recent pension reforms will end up costing the taxpayer billions of pounds.
The OBR said that new savings schemes and the removal of tax relief on pension for higher earners could cost the Exchequer £5billion a year.
The watchdog warned that higher earners will instead move money into tax efficient investments which could also drive up property prices.
It is simple and obvious that people will want and need income for the time when they stop work. We will still want to do things, pay bills, live a life once we stop working. What has become clear from Government and commentators is that getting people to save enough for a decent retirement is a conundrum that has yet to be solved.
George Osborne’s approach in the latter years of his Chancellorship was to simplify how you can use Pension savings – known as Pensions Freedom, a laudable approach that in a rational market would encourage savings through individuals trusting Government that they can use funds as they see fit.
The problem is that this would need a long-term to be accepted, understood and acted upon in relation to savings rates and would need to be left well alone by subsequent Chancellors. Neither of these is likely.
Further, there is an increasing feeling of a generational divide, where those who need to save more – principally the 20-35s – have little capacity to save and have an overriding and difficult goal of getting on the housing ladder.
The Baby Boomers, the 50-65s, are the last ones likely to have a secure and simple Final Salary pension, unless they are in the Public sector. They are also the generation most likely to have some spare income, having already finished in many cases paying off a mortgage.
It is no surprise that many of the Baby Boomer generation have seen buy-to-let as the right option in building a retirement pot. It is what they understand and trust and it is also largely free from Government tinkering, although that seems set to change with stamp duty changes and increased tax on rents already on the way or in place.
So what does Government do to encourage those who aren’t saving for retirement to start and for those who have started to do more?
Government has three levers it can pull:
- Incentivise. Tax relief has been effective for decades in persuading those who can to save into Pensions. The problem is that the older, more affluent are the ones saving.
- Automate. Put people into Pensions at work, make it difficult to leave and gradually increase the level they must contribute. The early signs are positive, we must hope that engagement is positive enough to stop too many jumping out when contributions get hotter.
- Persuade. PR, spin, nudge. Governments like this as it costs less than doing something and by the time everyone realises it was ineffective the persuader will be long gone.
In reality the public aren’t saving enough because of:
- Lack of Trust. They don’t trust Pensions, they are told not to daily, they have recent knowledge of their fathers, mothers, brothers and sisters being let down by things called Pensions over the last 30 years. Positive handling of this issue is difficult, long and slow.
- Change. Each idea and policy barely lasts a Parliament, so why change behaviour because next year we’ll be nudged in a different direction.
- Other pressures. The people who need to save the most have other priorities, for example, the young need to save for a house, while the poorer old don’t have spare income.
The one parallel that has been effective in getting those who can to save has been ISAs with £518 billion saved into ISAs – more than double the amount of 10 years ago.
So why has this been a success given there is no tax relief on offer in this market? The main difference is simplicity and stability, people understand ISAs. The reason why they are understood is because they have largely been left alone, limits have been tinkered with, but people get the tax breaks, they get the access they have and they trust the system. What is unclear is whether this will continue once the multitude of variations recently introduced start to sink in. We now have NISAs, JISAs, HISAs, H2SISAs and I’ve probably missed one or two in this list!
The reality is that to boost Pension savings, particularly for the young, the elephant in the room needs sorting first – housing. The cost of renting and buying is the issue of our time and until this is addressed we will not make more than a pin prick on the level of Pension savings.
Demand outstrips supply with the inevitable effect on price. Unless and until the housing market is changed to provide an affordable solution for the young and slightly less young, Pension funding will be a difficult problem to crack, but that doesn’t mean another decade of tinkering will have no effect. Every change and complication destroys confidence slowly but inexorably.
So, in summary, we need to do nothing, change nothing and let Pensions grow in public confidence like ISAs by leaving them alone.
It may not be a good time to be quoting US Republican Party Presidential candidates, but as Ronald Reagan was once quoted as saying: “Don’t just do something, stand there!”