With savers facing 100% of the potential downside of patient capital investment, as well as tax implications from the upside, Peter Glancy argues it is not the most enticing proposition.
The UK pension system represents around £2.5 trillion of assets - so it's no wonder the government is looking for ways to encourage investing some of that money to benefit the economy more generally, through what's called ‘patient capital'.
However, the majority of pension savers have little knowledge of investments. Scottish Widows research shows that just a third of savers are aware that the money in their pension is being invested. When we asked customers about their investment priorities, the number one ask was that their pension provider keeps their money safe.
Against this backdrop, only the wealthiest and most capable pension savers are in a position to invest in the ways that the government is encouraging. So why aren't they? The answer could lie in a specific roadblock: the way our tax system penalises investors whose pension pots exceed the ‘lifetime allowance.'
This is the level at which individuals start paying tax on their pension pots. Currently sitting at £1.05m, this is expected to increase in line with inflation in future years. While £1m sounds like a lot of money, that might buy an annual income of £35,000.
With this number in mind, it's not surprising that pension savers consider both the risks and the rewards before making any investment decisions. If an investment goes wrong, the investor bears 100% of the downside. An investment could perform well and yield a higher return than expected - but any investment which takes the individual beyond the lifetime allowance would attract a 55% tax penalty on the portion of the pension pot exceeding the allowance.
The unintended consequences of a complex tax system have received considerable attention recently, as it's become clear in how they are impacting the work patterns of doctors. Our research repeatedly shows that savers simply don't understand taxation.
The contrast between a pension and an ISA - which couldn't be starker - illustrates the nature of the challenge. When a customer asks about the tax benefits of saving into an ISA, we don't need to know their personal details - nor do we need to schedule regular check-ups to ensure our answer is still valid. The answer comes in one short sentence that applies to everyone: "You can save up to £20,000 annually free from capital gains tax."
In contrast, the tax system applying to pensions is almost unfathomable. A generic answer might be:
"Although it's called tax relief, it's primarily tax deferment. The marginal relief you receive depends on your marginal tax rate for each year of your working life, and your marginal tax rate for each year of your future retirement, adjusted for a tax-free lump sum of 25%.
"You can save up to £40,000 annually, unless your earnings pass a threshold, or you take any money out of your pension - in which case there are various other limits which could apply. The growth is free from capital gains tax, unless there is too much growth - in which case there will be a 55% tax charge."
It's not surprising that customers can't make sense of all of this and turn to financial advisers for help, which can be expensive. While customers with significant decisions to make will often benefit from good quality financial advice, we shouldn't create a system so complicated it requires customers to spend money simply to have it explained.
At Scottish Widows, we believe that it's time for a significant overhaul of long-term savings. But, given the current busy political and economic environment, now isn't the time for radical changes to our system of pension taxation.
Instead, it makes sense to first determine the long-term savings framework that best meets the needs of the nation going into the future, and only then determine a tax framework which best supports that new framework. However, where there are tactical opportunities to simplify the tax system in the short term, we would encourage the government to take them.
Peter Glancy is head of policy, pensions and investments at Scottish Widows
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