Talking Head: The Pensions Management Institute's Tim Middleton says it is time to rethink the increasing move towards cash in pension provision.
Part could be taken as a tax-free cash sum, but the majority had to be in the form of a guaranteed lifetime income stream – a pension.
The tax rules that imposed this rigidity offered in exchange some important concessions: all contributions were fully exempt from income tax, and contributions made by employers were not taxed as a benefit in kind. Benefits in payment were taxed as earned income.
As recently as the 1980s, this system worked extremely well. Defined benefit schemes were commonplace and were extensively used by employers as efficient HR tools to manage redundancy exercises.
The recent proposals to replace the existing system of tax rules would complete the transition from the provision of income to the provision of cash
Their efficiency lay in being able to provide generous lifetime incomes at short notice, and many employees in their early fifties were only too pleased to be ‘made an offer they could not refuse’.
While cash sums were valued, it was the provision of a pension that made the system work.
Move to cash
Over the last two decades, orthodox thinking concerning the role of a registered pension scheme has undergone subtle change.
To a large extent, this has stemmed from the transition from DB to defined contribution provision. While a DC fund is supposed to be a means to an end, it has increasingly been seen as an end in itself, and it is this that has led to a shift in emphasis.
Increasingly, there is a view that pension schemes should provide benefits in the form of cash rather than an income.
The criticism of annuities stems from a perception that they represent poor value for money.
There is a perception that annuitants who die early in retirement have somehow been ‘cheated’ as they have not had their ‘money’s worth’. Yet the pooling of risk is a central principle of providing pensions.
There has also been criticism that registered pension schemes did not adequately facilitate intergenerational wealth transfer.
It is perhaps worth pausing to consider that historically this was never a complaint levelled against DB schemes, and intergenerational transfer was not the role of a pension scheme anyway.
This year’s freedom and choice reforms have further loosened the primacy of income provision. The uncrystallised funds pension lump sum has finally removed the requirement to provide an income at all.
At the same time, reform to the rules on transfers on death has made the transfer of uncrystallised funds a central part of estate planning. Now that intergenerational transfers are possible, will parents start to regard them as mandatory?
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The recent proposals to replace the existing system of tax rules would complete the transition from the provision of income to the provision of cash.
A taxed, exempt, exempt regime would convert registered pensions into something essentially the same as individual savings accounts. The Isa is an extremely useful financial product and cash sums will always be a valuable benefit.
However, effective workplace succession planning becomes all but impossible without a strong pension system.
In an era of increasing longevity, the guarantees offered by a lifetime income stream are increasingly important.
Perhaps it is time for a rethink. From the perception of social policy, have we not already undermined pension provision to a dangerous extent?
Tim Middleton is technical consultant at the Pensions Management Institute
