On 25 November 2010 Retirement Planner editor Helen Morrissey interviewed Axa Wealth's head of pensions development Mike Morrison about his thoughts on pension reform, most notably the results of the then impending consultation into annuitisation
Since the Coalition Government came to power we have seen a huge increase in the rate of pension reform. How do you feel this pension reform has been developing over recent months?
I am surprised so much progress has been made in such a short time. I must admit for the first time in a number of years I am starting to feel we are getting some proper legislation, bearing in mind the economic climate we are in, that hopefully will make pensions a bit simpler but also means there is still some incentive for people to save for a pension.
Where do you think the potential difficulties are? One issue that has come up is the flexible drawdown regime, whereby if people are able to meet this minimum income requirement, they can effectively draw down their pension pot as and when they see fit. How does that work with long-term care? Someone could have enough to meet this minimum income requirement, draw down the pension, but then five to 10 years later find they need to go into long-term care and that they are unable to pay so have to fall back on the State. Do you think this is an issue that could arise?
I think there is an issue there. I guess the thinking generally is that someone who has sufficient money to do flexible drawdown is not likely to spend the rest of their money. They will have other assets and those other assets would go towards long-term care. But I agree that if you do have a minimum income requirement, and for whatever reason, someone’s investment portfolio disappears, then that’s all they have and you have created a potential State problem.
The same thing happens with pensions and divorce. That minimum income requirement, could it be subject to a pension sharing order? If it was, again you would have someone who would have less than the minimum income requirement. It’s almost the unintended consequences of setting a minimum income requirement while allowing people to spend the rest of their money.
Another issue that was brought up alongside this consultation was the tax treatment on death. A figure of 55% has been put forward – is that a fair figure?
We have to remember that 55% was put to HMRC by the industry several years ago, but I think it was put really as a composite rate of tax for a 40% taxpayer. So 40% to get your tax relief back, a little bit for gross rollup, and a bit for your tax free lump sum, giving you 55%.
Now I think a similar level of tax for a basic rate taxpayer would be something along the lines of 39%. So I think the real problem lies with those people who are basic rate taxpayers. If suddenly it’s gone from 35% tax to 55% tax, is there still an incentive for them to pay into pensions?
Now the other thing I think the consultation should have considered is the issue of having a 55% tax on your pension fund, but 40% inheritance tax outside of your pension fund. This still encourages people to take their money out of their pension fund to try and leave it to their beneficiaries subject potentially only to inheritance tax. Would it not have been better to perhaps have had 40%, or kept it at 35%, so it was more beneficial to leave it in the pension fund?
In reality, how much do you think flexible drawdown is going to be used?
That’s a good question because I am not sure there is a massive market for it. Even for those who make the minimum income requirement, would they really want to take out the remainder of their pension fund and lose 50% of it in tax? Would they not rather phase it out over a period of time, which you could probably do with capped drawdown anyway?
There are other consequences as well, things like overseas residence. If you are subject to a 50% tax rate here, but you could become a tax resident in a country with a lower rate of income tax, would that not encourage people to become tax resident in other countries with lower rates of tax?
In reality, how big an impact is the result of this consultation going to have on the retiring population as a whole?
I think there will be a big effect. I think there are lots of influences on annuity rates at the moment, such as Solvency II or European court decisions possibly on unisex annuity rates. For me, the prognosis for annuity rates is downwards. As annuity rates fall, that will encourage more people to think they may get a better deal by doing income drawdown. The more people that do drawdown means there are fewer standard lives in the annuity pool, which means annuity rates continue down. So we have a self-perpetuating spiral downwards.
I think the advisory issues around drawdown, capped drawdown, and flexible drawdown are considerable. There is a real chance that people could run out of money and this difficulty between balancing someone’s need for income and their risk profile is going to become one of the big issues in retirement planning.
We’ve also had changes to pension tax relief. What’s your view on this?
Well I think there are some good things that came out of it. Firstly, I think the industry was expecting a reduced annual allowance. We were expecting somewhere between £35,000 and £40,000. The recommendation in the legislation suggests it will be £50,000. So that’s a positive.
I know a lot of the responses from the industry said one of the fundamental principles of pensions is that the tax relief reflects the tax that you have paid. So for a 50% taxpayer, they should get 50% relief and again this was restored in the final draft. This is a sign of the government listening to industry representations.
Similarly, the issue about carrying forward your annual allowance for three years was something the industry put forward, particularly for the self-employed, or for small businesses, where sometimes cash flow is difficult. In some circumstances it might not be possible to pay a pension contribution every year. So I see it really as not £50,000 a year but £150,000 every three years.
One other issue which is more problematic is this reduction of the lifetime allowance from £1.8m to £1.5m. We are still awaiting the transitional rules on that to protect people whose pension funds are close to that amount.
However, I am not really sure why you need a lifetime allowance any more. If you have got a restriction on what you can put in, why do you need a restriction on what you can take out? A reduction in lifetime allowance just becomes in effect a tax on investment performance.
You have mentioned there are a lot of benefits to what the government has done. However, you have also mentioned some of the complications as well. Is there anything that you feel the government could have done differently?
I guess part of the consultation originally did think about removing pension input periods and aligning it with the tax year. While it would have taken away some of the opportunity, it would have made it much simpler. I think we could just leave the lifetime allowance alone. If you are lucky enough to be able to pay £50,000 in a year, whatever you take out at the end, subject to investment performance, is your benefit. Again, that would have made it easier.
I do think we are moving towards more of a commoditisation of pensions, where perhaps a client goes in to see his adviser, perhaps writes a cheque for £10,000 ISA payment and then writes a cheque for somewhere up to £50,000 pension contribution and then comes back next year and does the same. So if we can get to that simplification, I think it will be positive.
These changes replaced a regime that was considerably more complex than what we have at the moment. Do you feel this government has warded off another pensions crisis by bringing some of that much needed simplification back to pensions?
I think it has laid down the framework for it but it’s okay having the rules, but the rules don’t matter if no-one wants to put money in. So I think we are back to the issue of communication and how we encourage people to realise that pensions are still one of the most tax efficient ways of saving. So I think that communication of the importance of making your savings if you want to have a retirement standard much the same as your living standard before retirement is important.
Another potential issue that has been highlighted is that the rate of change is so rapid that we may potentially have a situation where a bit of a bottleneck
occurs. Do you think this is likely to happen?
I think it’s a real issue and I think it is down to providers and advisers to get used to new legislation, to make sure computer systems, literature, illustrations, all illustrate the new rules.
To listen to the entire interview please visit http://www.ifaonline.co.uk/professional-adviser/interview/1932085/audience-mike-morrison
Mike Morrison is head of pensions development at AXA Wealth
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