Goodbye Pensions, Hello IPSA
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Pensions existed for centuries for two main reasons – firstly, to get rid of faithful retainers who were past their sell by date (at any age) and, secondly, as a mark of gratitude for past service to the King, the church or the landed gentry.
The State traditionally also used pensions to buy off those who it removed from power in a non-fatal way or to reward meritorious service, but these were all one-off negotiated settlements, except for Naval and Army officers where it was contractual and intended to keep those concerned from offering their services to other nations.
In more recent times in almost all developed economies the State has become involved both as a provider and a regulator. Universal pensions for old age started, as with much other social insurance, with Bismarck who in 1899 established a pension scheme giving a retirement income from age 70, and this was also enacted in the British Isles in 1908. These benefits were means tested and intended to act as a ‘safety net’ to stop starvation rather than provide for comfort. In this role of acting to compulsorily transfer income from the young and employed to the old at a basic level the State does much the same today in the UK as it did in 1908 – but the level of the State Pension has risen and the age at which it can be claimed has fallen, and it is no longer means tested.
It is as a regulator of the private sector that the role of the State has expanded beyond anything ever envisaged and beyond anything which has any economic justification. Governments are right to have a safety net for the poorest in society but this is not age dependent. They are probably right to encourage individuals to save and invest when they are well paid and in employment to provide for any circumstances where they are neither. Again this is not age dependent. The government does both these things, and at all ages, but confuses the whole issue by putting in totally artificial distinctions (which would be illegal in the private sector) purely based on age.
It is time the government rid of age related discrimination with all benefits and savings rules. Effectively this means abolish the whole concept of pensions. In the private sector their intervention firstly to tax then to limit how much could be saved, both annually and in total, have come on top of detailed investment limits and a structure of control and reporting which makes the whole system more costly than any possible benefit.
Once upon a time the government had a simple view which said if you built up a fund tax free it did not matter as, one way or another, they would tax you when you received it as income, spent it or passed it on to your heirs.
Unfortunately, the consequence was so many saved so much that the pensions funds proved an irresistible target for the Chancellor of the Exchequer who, in the biggest secret theft of all time, took tens of billions of pounds out of everyone’s pensions schemes by the simple expedient of changing the Corporation Tax system from ‘imputation’ to ‘classical’ over a 6 year period starting in 1993. Such innocent words hid the change from a system where any earnings on ordinary shares were untaxed in Pension Funds to one where tax was paid. Because it was such an obscure change, and its impact took years to be felt, Mr Lamont, who first restricted the reclaims of pension funds, and all his successors had found a tax made in heaven.
Two things have followed – successive chancellors have vied to see how much more they can restrict reliefs previously given, and pensioners are collecting much lower pensions than they might have expected.
This is why we now have strict limits on contributions (to fall to £40,000 per annum in 2014/15), and on total sums invested of £1.25m. There are confiscatory taxes on surpluses when returned to companies or distributed.
Alongside this are fiendishly complicated rules on providers of all sorts, on companies to force them to contribute, and on what you can do with your money if you manage to save in this way.
So the time has come to forget pensions as a universal government sponsored, guaranteed and regulated form of income you collect at a specified age. Let us instead build upon another government initiative which arose from the completely non-political Meade Commission (1978) and a follow up from Mirrlees (2010) both of which point to towards the virtues of not taxing savings. (Or, the same thing put another way – only taxing spending). The academic case for neutrality in the tax system is unarguably good (and unchallenged) and the ISA is the (half hearted) response to this push for removing the incentive to spend rather than save.
If the chancellor were to announce an Integrated Pensions and Savings Account with exactly the same rules as ISAs, but limited in size to the sums of the current pension and ISA allowances (about £50,000 per annum) then he would at a stroke reduce the compliance costs of the private sector and the enforcement costs of the public sector very considerably – and to everyone’s benefit. He should allow all current pensions to be transferred into the new IPSA with no limits on either the maximum or on withdrawals, and should announce that all public sector pensions would be phased out with no more accrual of benefits to anyone – not even MPs or civil servants. Basically everyone would be encouraged to save at any age – but no-one compelled to or forced to stop on the basis of age alone. An upwards adjustment in pay for all public servants would be necessary for them to be able to fund their IPSA out of post-tax income – and one result of the reform would be that there would again be a level playing field between public and private sector jobs. It would take a brave chancellor to take on the life companies, his civil servants and his colleagues with index-linked non-contributory schemes all at one time – but perhaps we have one?
Any rational government would now call it a day – and just distinguish between tax free savings (IPSAs) and taxable. If pensions did not exist no-one would invent a form of state-sponsored saving with a 20,000 page rule book requiring 100,000 people to administer it. At worst the current system gives an illusion that most individuals will be able to retire on a satisfactory pension. At best it is an exceedingly over complex system which confuses almost everyone as to what they should expect. Goodbye pensions, hello integrated pensions and savings accounts.
For more information please visit http://www.nwbrown.co.uk/retirement-planning/
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