The DC Debate – judging the impact of the saver's Budget

Have the Budget changes to DC had a positive or negative net impact on retirement saving?

Tim Banks: The Budget changes have been positively received. The press supported giving people access to their own money at the timing of their choice. We will have to wait to gauge the longer-term impact, although we can predict with confidence that fewer annuities will be bought at earlier ages; that savers will take cash more quickly; and that for a sizeable cohort all the benefits will be taken as cash up front.

Laith Khalaf: Everyone who holds a pension is affected and we expect a flurry of scheme reviews over the next 12 months as employers assess whether their scheme is still fit for purpose. Members cannot default into an annuity anymore, which means schemes need to look at how they present retirement choices, alternatives to lifestyling default strategies, and increasing member education.

Andrew Dickson: The coverage highlighted the importance of saving for retirement and reminded us that, while saving can be challenging, we can look forward to spending it in future. Giving people greater freedom and choice will make pensions more attractive and is likely to boost saving levels. Whether concerns about people running out of savings during retirement will prove founded, time will tell.

Nita Tinn: The impact will be positive, however, it is hard to reconcile the policy of encouraging savings through the introduction of auto-enrolment with allowing individuals to access the whole of their retirement savings at age 55. I do not think younger members will give any more thought to how they save for retirement as for them age 55 is still too far away, however, older members will now have more freedom of choice which is generally a good thing, although many will find the choice too difficult and may still end up purchasing an annuity.

Nigel Aston: The changes will lead to higher savings levels and increased retirement confidence. Aside from the changes required by the pensions industry to accommodate the new reforms, one immediately positive outcome is that more people will be talking more about their retirement savings. In order to consider how they might ultimately use their pension pay-out, members need to give advance thought to savings levels. The more we have people thinking about what steps are needed to help them secure the retirement they expect for themselves, the better.

Mike Spink: We predict that the relaxations will be positive in terms of people’s inclination to save via a DC scheme. We now expect opt-out rates for small and medium enterprises to be lower. Similarly, we also expect an increase in the level of discretionary DC investment, ie contributions above scheme minima.

What products will those approaching retirement need, now the effective requirement to buy an annuity has been abolished?

Aston: Default funds, currently relied on by 80–90 per cent of savers to take them to retirement, are well positioned to be the natural vehicle to also take them through retirement and give them more predictability about their retirement income. More advanced default funds will be reversible, unlike an annuity purchase. They will have an investment mix that can be updated and evolve as markets, legislation and behaviours dictate.

Dickson: Fiduciaries of DC default pensions will be preparing to review their current investment strategies. Some employers will take the view that once employees reach their selected or state pension age that their pension planning becomes an individual responsibility. Other employers will take a more paternalistic approach and support alternative investment strategies ‘to and through’ retirement –we have seen this in Australia and the US.

Spink: Trustees and their scheme sponsors will want to consider how their scheme can facilitate drawdown. This will require a review of existing default strategies. The private market will need to innovate to have any chance of unlocking assets being managed by occupational pension schemes. Such innovation may take the form of products wrapping investment advice with taxation advice.

Banks: Members will continue to need a default journey until such time as they gain certainty about their choices. It is unrealistic to expect most 55-year-olds to know with certainty when and how they will use their benefits. Many will continue to choose not to engage, even when guidance is provided. Schemes will need to react to the changes to provide defaults that cater for uncertainty. Drawdown will play a much bigger role.

Khalaf: I suspect there will be raft of new products launched to capitalise on this opportunity, probably including guaranteed investment products. Unfortunately the reality is there is no magic money tree. These products will invest in the same markets as more traditional funds, and guarantees cost a lot – many of these products will overpromise and underdeliver. There are already funds on the market which will suit retiring investors, like absolute return funds and equity income funds.

Tinn: Default strategies will have to change so that members are channelled into the right vehicle targeting either annuity purchase, drawdown, remaining invested or cash. Given the need for some certainty as people age, we should still be looking at whole or partial annuities, where people can effectively buy slices of income over a period of years for all or part of their retirement, thereby spreading the risk associated with a single annuity purchase.

Steve Webb has proposed a 30 per cent flat rate pensions tax relief. What impact would this have on DC members?

Dickson: This approach would certainly simplify communications regarding tax incentives for pensions – however it would represent another change to the rules. The danger of again changing the tax treatment of pensions is that it might further disenfranchise sections of society from involvement in pensions. Such restrictions can result in key corporate decision-makers having no aligned interest in the scheme.

Aston: The strongest influences towards positive DC saving decisions are initiated by the employer. Unfortunately, tax relief carries the disadvantages of being poorly understood by most savers and disproportionately attractive to the wealthiest. In our 2013 survey, only 1 per cent of savers cited improved tax advantages as a motivator to greater saving. Regulatory changes are just part of the savings behavioural equation.

Tinn: Evidence suggests that until the advent of auto-enrolment many people chose not to join their employer’s pension schemes thereby losing the benefits not only of the tax relief on their own contributions but also the additional contributions from their employer, therefore I do not believe the increased tax relief will change savings behaviour among lower earners.

Spink: For basic-rate taxpayers, a new flat rate 30 per cent tax relief might give rise to an increase in contributions and, therefore, enhanced retirement outcomes. Where the individual pays tax at higher or additional rates, some form of review would have to take place in respect of discretionary pension investments.

Khalaf: It would make tax relief easier for members to understand, but it would lead to pension saving being less attractive for higher-rate taxpayers. If this is judged to be an acceptable price to pay now, it may not be in the future. The higher-rate tax threshold is subject to fiscal drag, which means it doesn’t tend to increase by as much as wages, so increasingly people pay tax at the higher rate.

Banks: Changing the well-established tax framework would lead to a further disenfranchisement of the decision-makers, who may well come to regard pensions as a minimum-compliance exercise.

Is it a good idea to level the playing field? Or is it another unnecessary disincentive against retirement saving?

Dickson: Due to the way our current tax bands operate, it is possible for some savers to benefit from higher-rate tax relief and to then pay only basic rate tax on retirement income, making them net beneficiaries of the system. A flat rate of 30 per cent tax relief would level the playing field in that respect.

Spink: Although basic-rate taxpayers make half of all pension contributions, they only benefit from 30 per cent of the total tax relief. Some form of levelling measure makes sense: the proposal should see higher contributions being paid by a significant proportion of those saving via a pension scheme, with all of the benefits gained from having a better-resourced retirement population.

Khalaf: Any change to pension tax incentives should be supported by strong empirical evidence that it will increase retirement saving, rather than by political rhetoric. Gordon Brown’s abolition of tax credits on dividends received by pension schemes is a sobering lesson in what damage seemingly minor changes to tax rules can do to the pension system: the policy has cost pension schemes an estimated £118bn.

Banks: Levelling the playing field would be a brave decision, in particular given the number of public sector workers now in higher-rate tax brackets paying higher contributions for defined benefit pensions. Any changing of the tax framework could have a material impact on the numbers of people using retirement savings products for discretionary savings, preferring the certainty of tax treatment in other savings products.

Aston: There is a range of factors that influence savings rates more than tax incentives. A single tax rate, however, does bring the potential to introduce further complexity into a system that isn’t fully understood or appreciated by members.

Tinn: It is fair that those most able to save for retirement should not benefit to a greater extent than those on lower incomes. But piecemeal interference with individual aspects of personal taxation is bound to lead to some anomalies, with winners and losers, and should therefore only be tackled as part of a general overhaul of the system, including national insurance contributions.