Jonathan Stapleton analyses changes in UK pensions legislation heralded by its emergency Budget in June and the series of announcements surrounding it
The UK coalition government’s first budget, held on June 22, was primarily designed to set out a range of spending cuts and tax rises to tackle the country’s budget deficit, which, according to forecasts from the European Commission, could hit 12% of gross domestic product this year.
Yet the Budget – as well as several announcements around it – is also likely to have a significant impact on the UK’s pensions system, both for defined benefit and defined contribution schemes.
Public sector scheme reform
One of the first moves the government announced, three days ahead of the Budget, was the establishment of an independent commission to look at ways of reducing the costs of public sector pensions.
The commission, to be led by John Hutton, a secretary of state for work and pensions in the last government, was tasked with undertaking a “fundamental structural review” of public service pension provision in time for the budget next year.
The government said it would produce an interim report in September this year – ahead of a planned spending review.
The commission will look at all the major public sector schemes – including both unfunded schemes, such as the civil service and National Health Service schemes, and funded schemes such as the Local Government Pension Scheme (LGPS) – and make recommendations on how public service pensions can be made “sustainable and affordable” in the long-term.
This follows predictions from the Office for Budget Responsibility, the body set up to make an independent assessment of public finances, that the gap between contributions and pensions in payment in public sector schemes is set to more than double over the next four years to £9bn (US$13.5bn).
Commenting on the move, chancellor George Osborne explained: “The long-term sustainability and affordability of public sector pensions is crucial for sustainable public finances both in the UK and internationally.
“We must consider options for reform that are fair to the taxpayer and to people who work in the public sector.”
Tax relief alternatives
The Budget itself announced consultations on several areas of pensions – the most important involved a look at “alternative ways” to implement pension tax relief restrictions.
In the UK, contributions to registered pension schemes are currently exempt from tax – subject to an annual contribution maximum of £255,000 and a lifetime maximum of £1.8m.
However, in the 2009 Budget report, the former Labour government announced it would restrict the 40% higher-rate tax relief on pension contributions for people with incomes over £150,000 from April 2011. This would mean these high earners could only enjoy tax relief at the basic rate of 20%. Following consultation, the former government announced it would reduce the income limit to £130,000.
Pension professionals almost unanimously branded this approach to the restriction of tax relief as a retrograde step – and called for the government to think of a simpler alternative.
While the new coalition government will still go ahead with the plans to restrict tax relief on pension contributions it has listened to the call for greater simplicity. In the Budget, Osborne said he would work with the industry on “alternative ways” to implement the restrictions – and was considering reducing the annual allowance from £255,000 to as little as £30,000. Such a move would be much simpler for the industry to implement.
National Association of Pension Funds chief executive Joanne Segars explained: “The previous government’s proposals were a disaster in the making. They would have been very damaging to the pensions of all working people, not just the well-off.
“Reducing the amount that can be paid into a pension tax-free each year will protect the Treasury’s tax take, but will be much more supportive to pensions saving and less costly to implement.”
Association of Consulting Actuaries chairman Stuart Southall added: “While it is disappointing, but perhaps inevitable, that the government still intends to levy tax on pensions savings, we welcome the announcement of a review of how this is to be done, and the target of greater simplicity, provided this is genuinely delivered.”
In his Budget, Osborne also announced the government would scrap the rule which creates an effective obligation for scheme members to purchase an annuity by the time they reach the age of 75.
In a document published alongside the Budget, the government said it would scrap the so-called age 75 rule from April 2011 – and said a consultation on the detail of this change would be launched “shortly”.
It said legislation for transitional arrangements for those who will reach 75 in the meantime – and have not yet bought an annuity – would be introduced in due course.
AllianceBernstein head of DC research and design David Hutchins said: “The additional flexibility that an end to compulsory annuitisation will bring to individuals saving for retirement should be welcomed.”
However Hutchins warned the government to avoid the complex rules and regulatory requirements he said had often accompanied attempts at bringing greater flexibility in the past.
He said: “While this has been a significant benefit to the pensions industry and financial advisers it has as a result left savers worse off and often excluded the valuable benefits of flexibility from the less well off – an approach which is akin to keeping the poor, poor.”
Despite this, Partnership, a specialist annuities firm, warned the abolition of the age-75 rule would be of “limited benefit”.
Head of retirement Andrew Megson explained the number of people who currently annuitised at over the age of 70 was the smallest percentage of all annuity transactions.
He said: “There is no way the cost of this change can deliver more than a limited benefit.”
“In our view, the government should be putting its limited resources into making sure consumers are aware of the Open Market Option to shop around for the best annuity by making it a mandatory part of the retirement process,” Megson continued.
Two days after the Budget, the government outlined what it described as a “radical agenda” on how to improve pensions in the UK.
Secretary of state for work and pensions Iain Duncan Smith said the government would restore the link between state pensions and earnings from 2011. Currently the UK’s basic state pension – paid to everyone aged over 65, subject to certain employment-based requirements – only rises in line with inflation, a much lower rate.
It also called for evidence from the public and interested parties about speeding up plans to raise the state pension age for men to 66, possibly by as early as 2016. The previous Labour government’s policy was to raise the pension age to 66 in 2024 and then gradually to 68 by 2046
The government also said it would consult on how quickly to phase out the default retirement age, which allows employers to force staff to retire at 65.
In addition, it said it would also undertake an independent review – led by manufacturers organisation EEF head of employment policy David Yeandle, Legal & General pensions strategy director Adrian Boulding, and Institute for Fiscal Studies research fellow Paul Johnson – into how to make auto-enrolment work.
Currently the government is planning to introduce a programme of auto-enrolment – where all employees will be automatically signed-up for a pension plan, but can subsequently opt-out should they wish – from 2012.
Commenting on the proposals, Duncan Smith explained: “Britain used to have a pensions system to be proud of, but due to years of neglect and inaction we are left with fewer people saving into a pension every year and the value of the state pension has been eroded, leaving millions in poverty. We must live up to our responsibility to reinvigorate the pension landscape.”
Pensions minister Steve Webb added: “I’ve worked all my life to get a fairer deal for pensioners. Up to 10 million people are not saving enough and we cannot allow this situation to continue.”
At a glance
- Independent commission established to look at ways of reducing the cost of public sector pensions. The commission, to be led by former secretary of state for work and pensions John Hutton, will undertake a “fundamental structural review” of public service pension provision in time for the next Budget in 2011. An interim report will be published in September ahead of the government’s spending review
- The government to work with the pensions industry on “alternative ways” to implement pension contribution tax relief restrictions. It said it was considering reducing the annual allowance to as little as £30,000 instead of implementing the more complex plans laid out by the previous government. However, it said it needed to protect the £3.5bn of revenue the tax restrictions would bring in and was, therefore, not scrapping the policy completely.
- Age-75 rule obliging scheme members to buy an annuity before they reach 75 to be scrapped. The government said it would consult on details “shortly” and introduce transitional arrangements in due course.
- Restore the link between state pensions and earnings from 2011. Currently state pensions are only linked to inflation, a much lower rate of increase.
- The government is to speed up plans to raise the state pension age for men to 66, possibly by as early as 2016. Ministers will also raise the option of extending it further, perhaps to 70 and beyond in the following decades.
- Independent review set up to look at how to make auto-enrolment work.
- Consultation launched to decide how quickly to phase out the default retirement age (DRA). Currently, employers can force staff to retire at 65 – once the DRA is abolished, this will no longer be allowed.
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