Pensions simplification is the grand ambition the government claimed back in 2001 when it announced a review of the rules on pensions designed to encourage more people to save for their retirement.
The slow process of moving from ambition to realisation will be reached in April 2006, but some commentators are questioning whether the government will achieve what it set out to do.
The rules that govern pensions have been built up over the years in layer upon layer, like an overblown wedding cake. There are varying tax rules, benefit rules and administration rules for different types of scheme and even for individuals with different starting dates.
It is so complex that trying to work out where you are with the various pensions you have and what you should do with them requires expensive advice.
This complexity is one of the barriers seen to be putting people off saving in a pension. So the plan is to throw out many of these rules and start again with a new set that will apply to all pensions, regardless of when they started.
The tax rules are the ones for the chop, and the final shape of the new rules is now nearly clear, as the Finance Bill that will introduce them is being debated in the Commons. These govern how much people can pay into their pension, the investments they can hold and how and when they can take money out of their plans.
The plan to simplify the taxation regime for pensions was applauded by the pensions industry when the proposals were first published in December 2002, and is still widely supported.
But experts say the delivery of simplification is proving complex. Consultant PricewaterhouseCoopers says the new rules will not reduce the eight existing tax regimes to one as the government intends, but will create six separate regimes, although five of these are irrelevant to the vast majority of pension savers.
Trevor Llanwarne, chief actuary of pensions at PwC, says: “The fact that we are back up to six regimes and that over a quarter of the [Finance] Bill’s 550 pages are devoted to pensions issues, illustrates how complex it is to actually deliver simplification.”
He acknowledges that the changes will “deliver real benefit for 98 per cent of the UK’s workforce”, but says they will create enormous demand for advice from the remaining 2 per cent.
These are the people with large pension pots likely to be affected by the lifetime allowance of £1.5m, who would be liable to tax of 55 per cent on any excess over this amount.
They are still waiting for full clarification of exactly what the new rules mean. But the good news is that most of the updates coming out of the consultation and debating process are positive, although there is little doubt they detract from the simplicity.
Ruth Kelly, financial secretary to the Treasury, recently revealed that the rules allow the possibility of valuing a pension fund in a way that effectively allows a higher amount than the £1.5m limit to be used to buy a pension.
Rather than using the size of the fund as the test, it is possible to use a multiple of 20 times the annual pension amount. This is the test that will apply to defined benefit occupational pensions that pay a pension linked to salary and length of service. Critics say this can give a more favourable outcome and allow people retiring at age 55 or 60 to spend £2.3m on their pension.
There is some doubt over how useful this loophole will prove, though, as it depends on pension companies providing the appropriate vehicle. Mike Morrison, pension strategy managers at Winterthur Life, says it is “a bit of a red herring”.
“What people are saying is that, if the income is paid from scheme assets, [rather than via an annuity] both final salary and money purchase plans can pay a pension of £75,000 a year. If you build in bells and whistles, such as inflation protection and spouse’s pension, it costs £2.3m to pay for it. But the smaller schemes won’t want the hassle of paying pensions from scheme assets,” says Morrison.
The Treasury says the rules offer flexibility that will be attractive to some people, depending on their individual circumstances.
Andy Bell, consulting actuary at AJ Bell, says this situation is just one example of the anomalies that emerge from dealing with defined benefit and defined contribution (money purchase) schemes under the same rules.
“The government is trying to put too much in one box, and the result is over-complication,” says Bell.
He finds some of the other opportunities the new rules will offer to high earners just as anomalous, at least with the Inland Revenue’s stated views on what pensions are for.
“It has always been a fundamental principle that a pension plan was to be used to provide a retirement income. But under the new rules, you can put investments in your pension, such as residential property, that do not generate an income, and you never actually have to draw a pension.”
If you take an income from your fund, instead of buying an annuity, the minimum income allowed is zero. You can carry on taking no pension until you die, and the assets in the fund will then either be used to provide a pension for your dependants, or pass to other members of the scheme, which could include your children or grandchildren.
Bell is concerned that the Treasury has not taken on board how attractive such opportunities may prove for high earners. “Ruth Kelly has not got a grip on the consumer reaction to all this, unless her judgment is that it is not important if less than 100,00 people take advantage.”
He says the Revenue could lose out on tax revenue with people taking advantage of the new rules, and fears that the government may add new rules after a few years that will threaten the simplicity it is striving for.
Martin Cadman, chairman of the Sipp provider group, says the government has given itself the power to make regulations in all sorts of areas, “so they can row things back”. But he says the Revenue is taking the view that it can police pensions through self-assessment, in the same way as tax.
Whatever the pros and cons of simplifying the pensions regime, one common view is that the initiative will not be enough on its own to encourage greater saving.
Michael Pomery of Hewitt Bacon & Woodrow says the change is “a necessary but not sufficient condition”. There are other complications and barriers to saving that the government reforms are not tackling.
Independent pensions expert Ros Altmann says the whole package will not make any difference to people, except at the top level, who were doing fine under the current system.
“It is like a whole big exercise to not increase people’s pensions. Although it will be simpler, it is not going to encourage lower and middle-income people to save. There is no real incentive for anyone who is not a higher rate taxpayer.”
Pauline Skypala
