Workplace savings will never be the same again
So we heard in yesterday’s annual Budget that from April 2016 you cannot save more than £1 million into your pension pot(s) over your lifetime (known as the lifetime allowance or LTA), otherwise you will be stung by a 55% tax charge.
We also learnt that from April 2016 the annual ISA rate will increase to £15,200 (currently at £15,000 a year) and lower rate tax payers will be able earn up to £1,000 in interest on savings tax free.
This is going to fundamentally shift how people save, and what will be attractive as workplace savings.
Steve Bee, the pensions expert and blogger said on Twitter:
People can now put more into their ISA than they and their employer can put in their pension in their lifetime. How did that happen?.
I can’t quite work out his maths, but I get his point.
This is the time for employers to schedule in a re-look at the way they offer savings to staff. There are likely to be new opportunities for those wanting to be innovative (admittedly we need to see the full details first).
In the meantime here are some interesting comments and figures from the experts in the implications of the reduced LTA:
- Reducing the Lifetime Allowance to £1 million is only expected to impact 4% of people reaching retirement in the near future but it will affect more and more people over time – Kevin Davey, principal at Mercer.
- It’s also worth bearing in mind that the LTA now limits DC pensioners to an income which is probably below the national average earnings for full-time employees (£29,536pa) - Lynda Whitney, partner at Aon Hewitt.
- Although a million pounds still appears to be, and is, a very large sum of money, which clearly is beyond the aspirations of the average pension saver, it does mean that for a defined contribution pension pot it actually only produces an annual pension of little more than £27,000 (inflation proofed and providing for a spouse) - Malcolm McLean, senior consultant, Barnett Waddingham.
- There has recently been a call for an increase in the level of total contributions to a pension arrangement to 15% of salary. For a 25 year old saver currently on a £30,000 salary then, using standard illustrations this participant would accumulate pension savings of £1.1m over his working life, which is in excess of the LTA. This cannot be the government’s objective – Brian Henderson, Partner at Mercer.
- There is a stark inconsistency between the effects of the new Lifetime Allowance (LTA) of £1 million on defined benefit (DB) and defined contribution (DC) pensions. In the DC world, £1 million may buy an increasing pension of only around £25,000pa, while in the DB world you are allowed a pension of £50,000pa without breaching the Lifetime Allowance (LTA). This is because HMRC uses a fixed factor of 20 to calculate the LTA for a DB member and you cannot currently buy £1pa of increasing pension for anything like as low as a £20 premium – Lynda Whitney, partner at Aon Hewitt.
- The reduction in the annual Lifetime Allowance (LTA) to £1 million will hit DC savers harder than DB members. Under current rules, a DB pension of £50,000 will be impacted by the penalty tax charge. In contrast, an equivalent DC saver will only be able to receive a much smaller annuity before they are affected by the penalty tax charge. We estimate that a DC member will typically be able to buy a pension of under £25,000 a year based on current annuity rates – Brian Henderson, partner at Mercer.
- The removal of National Insurance (NI) for those under the age of 21 will have a perverse outcome for pension savings. Most pension schemes now use salary sacrifice so that pension contributions are NI free as well as tax-free, cutting the cost to the member of pensions saving. Unfortunately, this NI benefit will no longer be available to those under 21. This will increase the cost of pensions savings by 12% for a typical person under the age of 21 – Lynda Whitney, partner at Aon Hewitt.
- The changes announced today may well herald a new era for employers and the benefits packages offered to employees. Weakening the tax breaks on pensions and promoting ISA reliefs could be seen as advance notice by the Treasury that they have their sights set on an integrated savings regime, covering both long term and short term savings – collapsing pension and ISA tax reliefs into a single system – Kevin Wesbroom, senior partner at Aon Hewitt.
The calculations and figures above might vary, but it is clear that at best defined contribution members will be saving for an average salary level as a pension in retirement, hopefully topped up with ISA savings.
I expect that for the vast majority this is as much as we could ever hope to save anyway.
For better or for worse.