The budget statement in parliament is a fabulous piece of political theatre and - with this most ‘political’ of chancellors giving his final budget before an imminent and very uncertain election it was as ‘political’ as could be.
I learnt a long time ago not to get too hung up on the actual ‘words’ in the speech (fun though they can be – unless you are the leader of the opposition who has to make an immediate and detailed riposte) but to wait for the press releases that come once the chancellor has sat down. Generally there is a great deal more to think about when you actually have the words.
So, from a ‘life and pensions’ perspective, there were several changes concerning the creation of a secondary annuity market, an increase in the lifetime allowance to £1m and some tinkering with ISAs to make them more interesting.
Yes, individuals in receipt of a pension annuity bought from a DC pension scheme will be able to exchange that for cash – that’s the headline. But the command paper for pension anoraks sets out in some detail how HMG thinks this fairly radical change might work.
Firstly, it is a consultation document and there are a series of mainly closed questions that ask ‘do you agree…..’. Annuity providers and potential ‘annuity unlockers’ will no doubt respond – but the numbers released by the Treasurer do show there is an expectation that this process will provide a tax windfall for HMG – not that I’m cynical.
Secondly the Treasury have thought it through to an extent. The tax consequences of ‘selling’ an annuity are clear; it will be taxable at the former annuitant’s marginal rate (unless you put it into another ‘retirement’ product such as drawdown when the actual payments from the new product will be taxable) and there is no new pension commencement lump sum or allocation against your lifetime allowance. The existing annuity provider won’t be able to ‘buy it back’ to stop consumers thinking they have to do that, and to save providers having to dispose of underlying supporting assets at an unfavourable time (that’s HMG’s logic, not mine).
So, is this a great opportunity for consumers and/or providers? Maybe for some – but if you think annuities are poor value just wait until you see what a second hand one is worth!
The second pension change concerns the lifetime allowance (LTA for short); the total amount of money an individual can have in his pension pot before paying a penal rate of tax on it. This concept was invented in 2006 together with a pile of other pension changes laughingly called ‘pensions simplification’. The day they were to come into effect was referred to colloquially as ‘A’ day (‘A’ being short for ‘Appointed’ as in ‘…will come into effect on an appointed day’ – pension people aren’t that imaginative – good looking, but not imaginative).
The LTA started off at £1.5m, gradually went up to £1.8m in 2010 before coming down again in steps to £1.25m in the current year reducing to £1m in next as announced in the budget. For anyone interested in the full history have a look at the note produced by The Pension Advisory.
Background papers to the budget report this change will affect about 4% of pensioners so an effective tax break on the rich – a ‘good thing’, politically.
I’m not so sure (about the 4%, I’ve no view on the politics – and if I did have this isn’t the forum).
The problem is neither the Treasury or ONS actually know how many people are or will be in the bracket – their data comes from life offices and pension providers who know what their policyholders have (more or less) with them - but not what each individual has in aggregate.
Then there is the DB issue; with a DB scheme there isn’t a clearly identified pot of money, rather there is a ‘promise’ to pay a particular income stream at a particular point in the future so the legislation had to find a way to express that ‘promise’ in a way that the LTA rules could cope with. The legislation converts a DB pension ‘promise’ to a nominal cash equivalent using a simple 1:20 formula. In other words if you have a DB pension of £10,000 pa for purposes of calculating the LTA the £10k is converted thus:
20 x £10,000 = £200,000
The figure is then expressed as a % of the LTA when the DB pension is taken to allow for changes in the LTA – still with me. In this example and assuming the pension was taken when the LTA was £1.5m, the £200,000 would have been expressed as 13.3% of the LTA. So, if an individual had both DB and DC pension funds, and took them at different times (and financial planners tell me that is often the case today) then it would be the % that would be taken into account not the actual converted ‘cash equivalent’.
Today a £200,000 pension pot won’t buy anything like an indexed linked pension income of £10,000 a year with a two third spouses benefit at age 55 – indeed the new £1m limit would barely provide that. Some have argued that this conversion metric discriminates against the DC holders and for the public sector who are still in DB schemes – indeed the distinction has been called ‘pensions apartheid’.
Probably too much detail for a ‘fintech’ audience – but the sort of thing consumers are going to have to grapple with as they are thinking about their own pension arrangements. There are few ‘tools’ out there readily accessible to consumers that help explain all this – it really is just a set of algorithms so something that could readily be done.
Now ISAs – so now you can put money into a cash ISA, take it out and put it back in again – but with the effective removal of tax on deposit accounts the benefits of a cash ISA for most people are questionable. But it all means a lot more systems work in the banks and the need to validate ‘returning’ ISAs.
The ‘Help to Buy’ ISA is a gimmick in my view; £200 a month with a max government ‘bonus’ of £3,000 when buying a first house will be used as a useful handout by the ‘banks of mum and dad’ who can afford to stump up the regular investment saving themselves a few grand.
But it all creates work for Fintech as providers scramble to put their offers ‘out there’ - to mention an historical precedent, Fidelity famously had the first PEP (predecessor to the ISA for the under 45s) within 24 hours of their announcement. Admittedly that was more a marketing stunt than the result of a carefully considered product build, but they did have application forms and were able to process them within a very short timeframe – I will admit to submitting applications numbered 0000000004 and 000000005 – an early claim to fame!
By Chris Robinson, Managing Partner, Contrado Consulting and bobsguide Contributing Editor