John Walbaum puts forward a different approach to helping retirees attain a decent income.
There has been much healthy and heated discussion around the complexity and cost of annuities in recent weeks. Individuals are concerned about being locked into an annuity, particularly if they could die early in the term. Further, annuity rates have fallen sharply because of low bond yields. It seems perverse that savings accrued over many years are converted at a single point, based on prevailing financial conditions.
There is also the problem of improving longevity. One approach is to defer retirement age. However, longevity is not advancing uniformly. The better off tend to enjoy longer average life-spans, so planned increases in state pension age will have an adverse impact on the less well off.
How might we improve these matters?
Could there be better integration of state pension with temporary income? If the proposed universal pension of £7,000 p.a. were payable from State Pension Age for 17 years (say) and then stepped up to £11,000 p.a., people with smaller amounts of DC pensions savings or deposit accounts could invest this to provide a temporary bridge payment until the higher level of state pension became payable.
The government should then introduce a special issue of index-linked gilts with a 17-year life, reserved for these pensioners. These gilts would repay capital steadily over the 17-year period along with interest, so that the annual amount is fixed in real terms. Any amount remaining unpaid on early death would transfer to a pensioner dependant or would become heritable estate, avoiding loss on early death. These gilts should have a guaranteed minimum coupon of RPI + 2% or prevailing rates if higher. The gilts would not be tradable, so would always be priced at real par value, protecting the coupon. Based on this guaranteed coupon, an investment of approximately £57,000 would provide £4,000 p.a. real over 17 years. The gilts would have repaid in full just at the point when the rise in state pension kicks in.
The amount that could be invested by any single pensioner would need to be limited, to say £100,000, to prevent this being used as for tax avoidance. This amount of £100,000 is sufficiently large to sweep up small pension pots and other pensioner savings, replacing annuities for this group of pensioners. This provides a simple government-backed alternative to annuities that is much easier to understand.
How much would this cost? Based on prevailing real yields, the annual subsidy would be 2% of issuance. If £100 billion of pensioner gilts were issued, the annual subsidy would be around £2 billion. This is a much smaller figure than the current higher rate tax relief on pension contributions. Further, pensioners spend their income. This looks like a more attractive way to get money into the economy than the current low interest rate policy that has savaged pensioner income. As the gilts are redeemed annually, the issued amount would be stable in real terms over time. Meanwhile, it provides the government with £100 billion for much needed infrastructure, significantly higher than the modest amounts currently under discussion.
Critics will say this just adds to national debt. Nevertheless, it is self-financed internal debt. Further, the amount of issuance is quite small relative to the off-balance sheet obligation for public service pension schemes and the subsidy would be spread across the broader population, reducing the feeling of apartheid. The step-up rate of pension after 17 years also appears costly, but will offset existing means-tested benefits for many. Wealthier pensioners might also seek to benefit, but that can be handled within the existing tax system.
John Walbaum is a partner at Hymans Robertson
Three years at Wells Fargo
Effective from 9 December 2019
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Continuing the Architas education series for clients.
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