British savers free to choose at last
WHAT a remarkable, extraordinary Budget. In recent years, the chancellor’s announcements have largely been ignored by the financial markets; not yesterday. This was the biggest market-moving Budget that I can remember, with the shares of many of the City’s blue chip financial companies crashing and others rocketing. It contained the greatest surprise in years – an astonishingly revolutionary shake-up of defined contribution pensions – as well as several other important changes.
Pension savers will no longer have to use their hard-earned cash pot to buy an annuity: instead, with some caveats, they will be able to dip into their savings as and when they like, paying just their usual marginal rate of income tax on the money they pull out. This will come as a huge boost to millions, transforming the way they look at their pensions and injecting huge flexibility into their personal finances. Contributions will even retain all of their current (admittedly dwindling) tax relief, though one must wonder for how long given that they were often seen to be a quid pro quo for the requirement to purchase an annuity.
It will still make sense for some people to purchase annuities – and perhaps for most to do so after they reach a certain age (80, perhaps). But pensions as we know them – a stream of income from the day you retire until you die – now look increasingly like a thing of the past. That is the reason why so many City firms suffered a collapse in their share price; a lucrative chunk of business, which only existed as a result of state regulation, is now going to be decimated.
Many people will keep their cash and live off their savings instead – with anything left at death passed on to their heirs. This radical reform is especially important given the roll-out of auto-enrolment and workplace pensions and the fact that millions more people will end up in defined contribution schemes over the next few years.
The truth is that pensions were already dying for a number of reasons, including tax and accounting changes, increasing longevity and much lower bond yields, a development exacerbated by quantitative easing. Those who bought an annuity during the past few years saw their returns annihilated; some also appeared to make the wrong choices when choosing an annuity provider. The system’s entire legitimacy was in question, and George Osborne was busily making matters worse by removing tax advantages and limiting the size of pension pots.
But yesterday, in one dramatic move, he regained the initiative on pensions by effectively abolishing them, and replacing them by what is in fact a new kind of long-term savings accounts. I argued recently that Osborne wouldn’t leave a legacy because he hasn’t actually changed very much, unlike Lord Howe, Lord Lawson or Gordon Brown. How wrong I was: Osborne’s legacy is this historic revolution in the provision of retirement savings. It is supply-side radicalism, albeit not of the sort anybody thought possible. The revolution came out of the blue: there was no consultation, in part because the reforms were of such a market-moving nature that any leak could have triggered insider trading.
What’s most stunning is that the reform trusts the individual, and not the state, to make the right decisions. This is an almost incredible – and certainly most welcome – partial conversion from the chancellor. It is a hugely counter-cultural move: in almost all other areas, individual responsibility is being reduced, paternalism is on the rise and caveat emptor is being eliminated. But not when it comes to looking after oneself in old age.
Needless to say, this belated embrace of individual liberty could fuel an outbreak of moral hazard, with people blowing their savings and then having to rely on the state. But the shift towards a simpler state pension and the ending of means-testing in this area means that this doesn’t matter as much as some believe. Sure, pensioners who have lost everything may have an incentive to vote for higher state pensions; but they already have that today. Freedom comes with risks – and some people are bound to mess up. But it’s a feature of the system, not a bug.
The reality is that Osborne’s revolution is just the start. If the state now trusts people to save for their own pensions, it may soon be open to considering a range of other individualised savings accounts for public services, of the sort that already exist in Singapore and elsewhere. Turning pension pots in savings accounts also means that some of the cash could be used to pay for long-term care.
Everything Osborne does is for a reason: he cares about politics, not principles. His big strategy is to appeal to older voters: they are more likely to vote than young ones, and many have switched to Ukip. He wants to bring them back to the Tories, hence the pension changes.
The other excellent reform in the Budget – the increase to £15,000 to the Isa limit, and its drastic liberalisation, allowing any mix of cash and equities and the right to switch – will appeal to the successful striving classes, another key constituency. They weren’t helped on the 40p tax rate, but they got this instead, which will hugely extend tax free savings.
But the pension change will also appeal to many young people: parents will be able to take cash out of their pension pots to help them onto the housing ladder, for example. Inter-generational transfers will be speeded up. Crucially, many more young and middle aged people will probably use pensions to save. But the converse will also be true: some older people will squander their retirement cash, and may seek to tap their kids. Many retirees will take cash out of their pension and buy homes, pushing up prices in a market that remains crippled by insufficient supply.
The Treasury assumes that the pension changes will actually raise revenues because so many people will start to withdraw cash from their pots. But the figures are guesswork. It could easily be that the outflow of cash is much larger, or smaller. The reforms could also quite conceivably lead to a huge spike in inflows into pensions, meaning far greater use of tax relief, which would cut income tax receipts. Nobody knows.
That said, not all of the savings agenda is benign. One part is outrageous – and that is the new, explicit bribe to pensioners with savings or financial assets (poor ones, or those that only hold illiquid property, get nothing). Anybody aged 65 or over (but nobody else) will be able to invest £10,000 in a new savings product paying rates that are much higher than anything the market can offer. This is shocking: because interest rates will clearly remain low, one group is being offered subsidised investments. This government is somehow able to believe simultaneously in a freer market and central planning.
But for once all the usual nonsense pales in comparison with the real story. This was a huge day for Britain’s savings culture, and the reforms, while not for the faint-hearted, are overwhelmingly positive. George Osborne’s liberalisation of pensions may yet go down in history as his great supply-side triumph.