In the last Budget, Chancellor George Osborne announced he was freeing up much of the pension market so people could take their money when they wanted – 25% of it tax free and the rest at their income tax rate.
Today, at the Conservative Conference, he has said that if over 75s do that and die, and there’s money that hasn’t been touched in their pension pot yet, instead of their estate paying the current 55% tax when its passed on; they’ll pay it at their marginal rate (full info in the death tax news story).
This is a big pre-election giveaway to older voters, likely on the back of the scares about UKIP defectors. At a first glance, both these proposals seem wonderful, giving people more choice in the pension market and a greater ability to leave it to their dependants. (I shall ignore the wider philosophical debate over cuts in inheritance tax – which is a tax to stop perpetuating inherited privilege and wealth – that’s a discussion for another day).
Yet I have some real concerns over unintended consequences – so I’m quickly bashing out this blog as a stream of consciousness. I’d love to know your opinion on it.
The issue isn’t people overspending, it’s people underspending
When the pension liberalisation policy was first launched, one big headline concerned the risk that people would simply cash in their pension, buy a Porsche and the state would have to look after them in their old age.
Of course this can happen, but I suspect only with a trivial number of people. In fact as I explained in my The Chancellor’s pension changes are wonderful and horrid blog, the real worry for me is the opposite of this.
I am concerned that someone who has a pension – be it £20,000 or £200,000 – when they retire at say 67 knows it must last them the rest of their life, and a natural fear means they will be very reticent to touch it.
It will be left sitting there and that worry that if they spend it now they will have no money later on in life, means they will leave it there growing but unused, not helping them in their life in the way that a pension is designed to.
That was the one benefit of an annuity: you cashed your money in and you got a payment each year for the rest of your life – a real genuine income. The big problem with annuities of course, was that the amount that you got wasn’t big enough.
Under the new system of pension freedom, the only way to really decide how much you should be spending each year is to know when you will die. Now that isn’t that easy, although actuarial charts and your health and situation can you give you a rough indication of when this will be.
Of course you could get it wrong, so as a rule of thumb I would assume you are going to die 10 years later than the prediction and spend your money accordingly. But I simply don’t believe people will do that. Take these examples…
If you look at people who saved up for retirement planning to live off their savings in the bank (as opposed to pension savings). With interest rates lower than inflation, effectively the money is shrinking. Therefore it makes logical sense to spend some of the capital to live off, as the income isn’t enough.
Yet the psychology of it means people are, albeit understandably, simply are unwilling to spend the capital that they have; they only want to live off the interest.
This situation I suspect will be mirrored for many in not using the cash in their pension pot too quickly.
The cutting of tax could make that worse
The idea is that the money can be just as efficiently left to your inheritors as it is for you to spend it. I think this will perpetuate this psychological problem. Of course, there are some more affluent people who will see it as a great way to be able to leave money to their dependants by not touching their pension and using other funds.
Yet many on lower incomes already have guilty old ages, worried they’re "spending my child’s inheritance", even though sometimes their children are more affluent and have better lives. Pension money is meant to be there for you, not your dependants, to give you a decent standard of living in your old age.
Yesterday when I was filming for my television roadshow, I spoke to the son of a woman who had a decent but not huge of amount in savings who was desperate to give it away to her children to avoid inheritance tax. She was 78 and in decent health, but what was she going to live on for the rest of her life?
So indeed my great fear with this change is more people will restrain and constrain their spending far too much on money that is supposed to support them – knowing it could go in an efficient way to their kids.
Would guidance and education alleviate the worry?
The Chancellor has said he wants people to take guidance when they take their pension so they will understand these issues. The amount of money initially put into the pot to fund this – up to £20m for the first two years – is actually relatively small for giving guidance to all pensioners; certainly if advising them the way I would prefer, at a proper level where people will take liability for the advice that is coming across, rather than what could just be generic twaddle if not done right.
So my great concern is not that I have a principled objection to the freedoms of the pension market, nor even necessarily to allowing people to inherit with lower tax. What I do worry about is that we do have a primarily financially underskilled population who are not equipped to deal with these issues.
We already know that from the fact that when people retired in the annuity market, even though there was an open market choice where they were able to go right across the market to get the best annuity rate, the majority of people (60%, according to a 2012 study by the Association of British Insurers) didn’t do that. Instead they just kept with their pension provider’s annuity so losing income every year for the rest of their life.
I don’t think that enough of the current generation retiring population (especially those with smaller pension pots) are well equipped enough to deal with the freedoms. You may call me paternalistic, but I think we need more protections in place to help people manage their finances well when they retire.
I’d love your thoughts?