As we prepare for the General Election on May 6 Tom Stevenson puts forward what he would like to see in a political manifesto
British people are not saving enough. Household savings are inadequate whether measured against historic levels or against the level required to support increased life expectancy in retirement. This matters because, based on current demographics and ongoing pressures on the public finances, it appears unlikely that the government will for the foreseeable future be in a position to fill the gap. It is not overstating things to say that the UK faces a savings crisis.
Against this backdrop, we at Fidelity International have thrown down the gauntlet to whoever forms the next Government to take seriously the plight of savers and to put in place a set of incentives that might rebuild a culture of prudent long-term financial planning. Our proposals are based around a desire to support an overall increase in savings levels, especially new saving from groups that are currently putting nothing aside, to encourage more persistent saving and to promote a whole-of-life approach to saving.
Our proposals include some new thinking about the savings crisis as well as other ideas which have already been mooted but not yet enacted. Crucially, however, the measures we suggest are affordable because they are based on better deployment of existing Exchequer support for medium and long-term savings rather than requiring an injection of new money. We know that, in today’s straitened times, anything else would be whistling in the wind.
The State currently provides encouragement to save through various ‘tax breaks’ and we recognise that any future plan to reduce the savings gap will be through this kind of monetary incentive. Other measures, such as better personal finance education and guidance, are clearly important, and we support them, but they are secondary to putting in place workable incentives.
Tax incentives can, however, be a blunt instrument with which to encourage new savings, not least because tax is so poorly understood by so many people. Recent research by Fidelity International came up with a number of scary conclusions including the facts that: almost one in five UK taxpayers do not know their income tax band; a quarter of people earning more than £50,000 a year think they pay the basic rate of income tax; and half of the population does not know anything about forthcoming changes to tax legislation.
Against this backdrop of ignorance it is too much to expect that incentives expressed purely in terms of tax reliefs will have a material impact on the habits of a population which has so vigorously embraced the spending over the savings habit.
The government has in fact taken steps recently to improve incentives, especially within the ISA regime where the £10,200 (now index-linked) annual allowance is enough to accommodate most people’s needs. We believe, however, that simply increasing the ISA limit does little to encourage new saving. Efforts should be directed rather at increasing the participation rate.
Our first proposal is related to ISAs, which today account for a relatively insignificant proportion of total government support for long-term savings – about £1.6 billion annually out of total support of more than £20 billion.
ISAs are popular but are perceived to offer only a limited incentive to save, especially for basic rate taxpayers. The ISA benefit also arises predominantly from interest-bearing investments and we believe that investors should see an equal incentive for equity investments.
With current investment levels of around £37.5 billion a year into ISAs an enhanced up-front incentive along the lines of the basic-rate pension contribution relief (20%) is likely to prove unaffordable, although it would encourage significant levels of new saving.
We propose instead the introduction of a smaller, up-front incentive payment, probably pitched at a relatively low level of 1% or so, but with the promise of a repeat payment annually for as long as the ISA remains open. Such a payment would have five clear advantages. It would be simple to understand, would encourage persistent savings (to pick up the annual top up), would be affordable (as the Government contribution would be spread over several years), would be fair (applying equally to equity as to interest-bearing investments) and would encourage new savings.
A related measure would be the re-instatement of the ability for investors to reclaim the dividend tax credit on equity income within an ISA, abolished in 2004. This simple measure would at a stroke allow ISAs to claim the ‘tax-free’ tag which would make them obviously attractive to a wide range of savers.
Our second proposal relates to pensions, which currently attract such a large slice of Government support – about £20 billion of the £22 billion currently directed at savings incentives – that measures have already been put in place to rein in incentives in this area.
The proposed tapering of tax relief for higher earners is ill-conceived for several reasons, not least because it makes pensions seem less attractive to the very people who currently make important decisions within big companies about the provision of pension benefits to their workforces. Most importantly, however, it sends out a confused message about the Government’s attitude towards retirement saving. It erodes the predictability of Government support for pensions and makes the administration and provision of benefits excessively complicated, hard to quantify and to understand.
We believe a better way of achieving the same policy goal (reducing the cost to the Exchequer of pension tax relief and removing the perceived bias of the incentive to higher earners) would be to set an annual cap on contributions at say £50,000 a year and to leave in place the simple system of offering tax relief at a saver’s marginal rate. The level of the cap could be adjusted to achieve different goals, including paying for any extra cost implied by the ISA incentive payments already suggested.
Our third proposal relates to the link between ISA and pension saving. Although greater incentives are applied to pension savings, the requirement to forgo access to saved capital acts as a serious disincentive to certain groups of savers, particularly younger ones for whom the flexibility to dip into savings at times of need is important.
We believe the Government should promote a whole-of-life savings culture by allowing transfers from ISAs to pensions in excess of the annual cap on pensions contributions. This simple measure would allow younger people to set out on the path to a secure retirement comfortable in the knowledge that their money would not be locked away until they felt ready to take that step in exchange for the up front tax incentive applied to a pension contribution.
A similar case could be made for transfers in excess of ISA limits of funds built up in Child Trust Funds to allow money built up from birth to systematically cascade down into a saver’s pension pot.
The final element of our whole-of-life proposals relates to the retirement years themselves. We believe the current system of compulsory annuitisation of pension pots acts as another disincentive to retirement saving and we argue for its abolition.
Compulsory annuitisation removes individual choice and responsibility. Having asked people to take personal responsibility for their financial security, it is unfair to exert excessive control over the way in which benefits can be taken. Clearly, some limits are necessary to ensure that people do not exhaust their savings and fall back on the state but these could be achieved with the introduction of an index-linked threshold level up to which pension pots have to be annuitised coupled with freedom above this level to draw down throughout life as the individual chooses.
The removal of the requirement to annuitise pension pots would also mitigate the perceived unfairness that these often substantial sums of money cannot be passed on at death, another serious disincentive to make long-term retirement provision.
A number of other less important measures would create greater flexibility in retirement such as a review of trivial commutation rules to allow for small pots to be taken as a cash lump sum. We also believe there is a case for allowing access in some clearly defined cases, such as long-term unemployment or serious illness, to at least a portion of an accumulated pension pot.
Finally, we would encourage the movement without delay to auto-enrolment into employer pension schemes and other measures such as automatic contribution increases as salaries rise. The Government should also review the interaction of means-tested benefits with medium and long-term savings, which we believe currently encourage some savers to believe that saving is not worthwhile.
The current system does not encourage a whole-of-life approach to wealth accumulation but we believe that the small number of changes proposed here could go a considerable way towards encouraging such a savings culture. Our straightforward and easy to understand proposals would promote the early adoption of a savings habit, the reassurance that savings could be accessed if required and the transfer of savings from unlocked to locked retirement savings. All of this could be achieved fairly and affordably.
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