RE: Strengthening the incentive to save: a consultation on pension tax relief

Transcription

1 30 September 2015 Pensions Consultation 2015 Pensions and Savings Team HM Treasury 1 Horse Guards Road London SW1A 2HQ Submitted via to: pensionsconsultation2015@hmtreasury.gsi.gov.uk RE: Strengthening the incentive to save: a consultation on pension tax relief Dear Sirs, BlackRock, Inc. (BlackRock) 1 is pleased to have the opportunity to respond the consultation on pension tax relief issued by HM Treasury. As a fiduciary for our clients, BlackRock supports a regulatory regime that increases transparency, protects investors, and facilitates responsible growth of capital markets while preserving consumer choice and assessing benefits versus implementation costs. We welcome the opportunity to address the issues raised by this consultation, and will continue to contribute to the thinking of HM Treasury on any specific issues raised in our response. Executive summary In the context of dramatic increases in longevity, it is key that individuals in the UK save more, and start earlier, if they are to achieve appropriate levels of retirement income. Simplification of the pensions tax regime will not of itself address the current savings gap, though transparency and consistency in the application of the tax regime could engender increased confidence in saving for retirement. Individuals need greater confidence in the regulatory and tax framework for saving over the long term. This requires increased transparency at many levels: Transparency and certainty over the long term policy framework for retirement savings. This is a prerequisite for individuals making investment decisions for their retirement needs many decades in the future. Individuals will also benefit from clarity as to what they need to save to achieve a given level of income. This needs underpinning by comprehensive advice and guidance from product providers and advisers to empower individual participation. Transparency as to the taxation and key features - such as the value for money - of welldesigned products, such as workplace pension plans, should continue to be a key focus. We have carefully considered HM Treasury s key principles for reform against what we see as the drivers for successful reform. To achieve the Government s overriding objective of increasing the savings rate, we recommend a focus on five key objectives: 1. Simple, transparent and fair tax treatment for pensions that provides a strong incentive for individuals to save 2. Increase saving through compulsory participation 1 BlackRock is one of the world s leading asset management firms. We manage assets on behalf of institutional and individual clients worldwide, across equity, fixed income, liquidity, real estate, alternatives, and multi-asset strategies. Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers and other financial institutions, as well as individuals around the world. 1

2 3. Ensure the long-term stability of the system 4. Maintain employer support for pensions 5. Promote a longer-term investment culture We recommend achieving these objectives by implementing the following: 1. Simple, transparent and fair tax treatment for pensions that provides a strong incentive for individuals to save We recommend: Maintaining the current exempt, exempt, taxed (EET) basis for pensions. In any move to a taxed, exempt, exempt (TEE) basis there are fundamental issues around whether future governments would commit to maintaining the tax exempt basis. There is also a high probability of confusion, operational cost and market fragmentation from running legacy pension pots on an EET basis in parallel with future pensions on a TEE basis. Maintaining the pensions lock regardless of tax treatment. Moving to a flat rate of tax relief to deliver more progressivity, rebranding tax relief as a government matching contribution. We also recommend considering ways of simplifying the payroll challenges for employers of this move. Removing the lifetime allowance, creating more certainty for younger savers and those who might otherwise refrain from saving into a pension due to concerns around exceeding limits on the value of their savings. Simplifying the annual allowance by putting in place a sustainable annual allowance of what individuals can contribute (i.e., remove the recently announced ratchet of the annual allowance from 40k down to 10k. We believe the goal of a more progressive application of tax relief would be achieved via a flat rate of tax relief rebranded as a matched government contribution). 2. Increase saving through compulsory participation The single most effective action to deliver long-term pension sustainability is a strict requirement for all individuals to save a specified percentage of their earnings. We therefore recommend: Introducing compulsory pension savings at an increased contribution rate, under the existing auto-enrolment framework. At the current trajectory, auto-enrolment is set to raise minimum Defined Contribution (DC) contributions to 8% of qualifying earnings by September 2018, but for most individuals this is unlikely to be sufficient. We recommend a minimum contribution rate of 15% of salary but encourage individuals to save at least 20% - this would be on a level with contributions made to private sector Defined Benefit (DB) schemes 2. Continuing to use the architecture of auto-enrolment to ensure that individuals saving in pension plans do not simply put their holdings in cash, thus protecting them against the risk of not saving enough, and protecting the real value of their savings from the effects of inflation. Phasing in higher contribution rates using auto-escalation techniques such as Save More Tomorrow. 2 ONS Occupational Schemes Survey 2014 showing that average total contribution rate was 20.9% of pensionable earnings 5.2% for members and 15.8 for employers. 2

3 3. Ensure the long-term stability of the system Government needs to convince individual savers that there is a stable pensions system. We recommend: Permitting fewer changes, to allow for clear and consistent long-term messaging, by setting up a clear framework to distinguish between major policy changes that require cross-party support and full public consultation, and ongoing second tier adjustments. Ensuring mid-term and long-term budget compatibility to underpin consistent policy. Gaining cross-party support, removing the habit of successive governments to alter the rules according to short-term priorities. Creating an independent, institutional framework (e.g. Office of Pension Responsibility) as a way of depoliticising the formation and maintenance of savings policy-making, and ensuring continuity. This would complement industry calls for a Savings Minister to coordinate long-term savings policy 3. This level of long-term institutional transparency would in turn help incentivise individuals to take a longer-term view of their savings. Providing a framework for individuals to access a coherent and holistic view of their retirement savings including pensions, ISAs and other potential sources of income. 4. Maintain employer support for pensions We recommend: Ensuring that employers (both the corporate entity and senior managers) remain incentivised, so that the workplace remains at the heart of pensions savings. Continuing to incentivise employers, in particular through National Insurance Contribution (NIC) relief, to contribute to workplace pensions, such as by matching contributions under the existing auto-enrolment framework, and to maintain an easy to use administrative framework for employees. Ensuring higher and additional rate taxpayers retain a stake in the pensions system. The relative size of their contributions is key to sustainability of DC schemes for the wider population. 5. Promote a longer-term investment culture We should not underestimate the cultural change required for individuals to take responsibility for their own retirement: The long-term savings and pension regime should reward those who lock away money for future retirement needs. Any reform of tax incentives should strengthen, not weaken, the link between pensions and long term investment. As part of our call for an Office of Pensions Responsibility and a Savings Minister, we also call for further reflection on the design of the pensions schemes of the future, to encourage investment in longer term asset - such as infrastructure that are key to the sustainable growth of the economy. 3 TSIP, Saving our Financial Future,

4 In particular we recommend focussing on mechanisms to encourage master trusts to invest in long-term assets that offer the potential to match the long term liabilities of the trust. As part of this assessment we would welcome renewed focus on collective DC schemes. We set out more detail on these key actions before answering the specific questions in the consultation. 1. Simple, transparent and fair tax treatment for pensions that provides a strong incentive for individuals to save We recognise the need for budget sustainability. There is, however, also a need for reliable public information as to the cost of maintaining the state pension under the triple lock and tax reliefs into private pensions, over both the short and medium term. The short-term cost to the budget also need to be weighed against long-term benefits of budget sustainability in the UK (See Point 2 below). Reform, don t abolish, existing system of tax reliefs We support reform of the current system of EET tax relief, rather than the more extreme proposal of moving to a TEE regime. We would however welcome changes to a number of key measures in the current system framework of tax relief, to make it more transparent: Maintain the current exempt, exempt, taxed (EET) basis. The benefit to savers of EET is that more is invested for longer, allowing compounding of return on capital plus the value of tax relief. This should generate larger pension pots, increasing the likelihood of individuals being able to achieve their retirement savings goals. In any move to a taxed, exempt, exempt (TEE) basis there are fundamental issues around whether future governments would commit to maintaining the tax exempt basis. There is also a high probability of confusion, operational cost and market fragmentation from running legacy pension pots on an EET basis in parallel with future pensions on a TEE basis. We support a more streamlined use of tax reliefs under the current system, targeting lower and middle income earners who need the most support by moving to a flat rate of tax relief to deliver more progressivity. We recommend rebranding tax relief as a government matching contribution. Terminology is important. The way reliefs work and the grossing up of percentages are not well understood. Branding any relief as a matching contribution from the government would meant that individuals can immediately grasp that for every 100 they contribute, the government has contributed an additional x, and their employer y. This could for example be shown as a single national rate of government pension matching contribution for DC schemes, with the state providing 1 for every 2 from the employee/individual ( Buy 2 get 1 free ).We support the outcomes of research commissioned by TISA from the Pensions Policy Institute on the benefits of a government matched contribution to pensions. 4 There are also likely to be presentational issues for HMT in the level of match that is equivalent to a marginal rate of relief. As the Investment Association has noted, a front end rate of relief of 30%/ 1 plus a tax free lump sum of 25% of the final fund sounds a lot more persuasive than a government match of 10%/ 1 in a TEE model. In a TEE model, a higher match rate would be needed to make the incentive more attractive to the individual, and this in turn would make the TEE system more expensive than EET. This highlights the importance of behavioural economics and the framing of tax incentives when designing an incentive structure. 4 E.g. TSIP, Saving our Financial Future,

5 Take employer payroll concerns into account when planning a move to a single rate of tax relief. A number of operational considerations have been highlighted by commentators and these will need to be worked through with proper consultation with industry participants to minimise the costs of implementation. Remove the lifetime allowance, creating more certainty for those who might otherwise refrain from saving into a pension due to concerns around exceeding limits on the value of their savings. As it stands, the lifetime allowance undermines the very personal responsibility that the Government is keen to promote. Simplify the annual allowance by putting in place a sustainable annual allowance of what individuals can contribute (i.e., remove the recently announced ratchet of the annual allowance from 40k down to 10k). The consultation is premised on the assumption that the Government is paying significantly more in tax relief than it is gathering in tax from pension/annuity income. Even before the April 2015 legislation changes, this premise has to be understood in the context of how reliefs are allocated. We note recent studies that indicate that a significant proportion of tax reliefs are allocated to funding deficits in DB schemes rather than to DC schemes which appear to be the focus of the much of the consultation. 5 Indeed, after the introduction of pension freedom, income tax raised on the lump sum payments allowed under the new regulations will be greater than the income raised on average pension/annuity incomes, after taking into account personal allowances, e.g. if someone takes an annual annuity of 1,000 they are unlikely to pay much tax each year, whereas a person receiving a small pot lump sum or an uncrystallised pension fund of, say, 9,000 or 19,000 will pay a one off tax charge if the draw down is in excess of their tax free lump sum. Given the number of drawdowns that have been taking place, this should represent a significant change to budget projections 6. The Government will see a significant rise in tax income in this and subsequent tax years as many of the new lump sums paid will generate tax income where many of the smaller annuities would not have done. The impact of these changes need to be factored in to any discussion of the continued sustainability of pension tax relief. 2. Increase saving through compulsory participation We welcome steps taken in recent years to ensure that UK citizens can meet the challenge of increasing longevity with confidence. In particular, raising the retirement age, introducing autoenrolment and the establishment of NEST have all contributed to improving the UK pension system sustainability in the long term. In particular, we welcome the effect that auto-enrolment has had on reducing the decline in pensions savings. The need for compulsory savings Significant as they are, these steps are not enough. Last year individuals in Britain put less than a tenth of their wages into savings 7 - less than their counterparts in nearly every other country in Europe. The wider European average is closer to 15%. This means there is still too great a risk that individuals are not saving sufficiently if they remain enrolled at the default contribution rate, or indeed that they will opt out of savings entirely. As the BlackRock Investor Pulse survey revealed, only two in five (43%) Britons know how much they should be saving for retirement, and 44% are not saving anything at all. Recent statistics from the Office for National Statistics (ONS) show that while total membership of private sector DC schemes has increased as a result of auto-enrolment, average contribution rates for private sector DC schemes have dropped to 4.7%. While this drop may be indicative of new members being enrolled at lower rates than 5 Towers Watson Perspectives: Ending higher rate tax relief on pension not as obvious as it seems, May Royal London, Research shows that pension freedoms customers are potentially losing out, 20 August The Telegraph, 31 October

6 existing members, it is nevertheless a powerful indicator of the scale of the challenge faced in raising average contribution rates for all. i8 To achieve an individual s long-term goals of retirement income, we need people to save more, and save earlier. We therefore recommend making an appropriate level of retirement saving compulsory, without the opportunity to opt out, at a rate that will provide a sustainable retirement income. As a point of reference, the Department of Work and Pensions (DWP) own calculations suggest a minimum level of 15% is required to meet replacement income levels 9. We suggest this should be a minimum rate but that where possible individuals should be encouraged to reach to match the typical contributions currently made to a typical private sector Defined Benefit (DB) scheme where contributions are currently in excess of 20% of an individual s salary. 10 Financial education plays an important role and is certainly improving, but at the moment it is poorly co-ordinated and sends out mixed messages. People are still inclined to borrow rather than save when making major purchases, and those who do save are prone to holding inappropriate levels of cash to meet their long-term income needs. It is also far too complicated and difficult to invest as a consequence. Many simply do not feel sufficiently confident to invest in stock or bond markets and as a result have far too high a dependence on cash. Our most recent Investor Pulse survey found that non-advised investors have a staggering 74% allocated to cash 11. Saving benefits everyone. It ensures growth, stability and prosperity for the future of the UK and its people. It provides businesses with capital to grow, while ensuring that poverty in old age becomes a thing of the past and that people avoid the financial desperation brought by excessive debt. A failure to narrow the savings gap could adversely affect the UK s GDP, so it is of critical economic as well as social importance. We acknowledge that a move to significantly higher contributions is not a move that can happen overnight. We believe there is much opportunity for using auto-escalation techniques, and save more tomorrow schemes. How can save more tomorrow schemes provide the answer? The US has provided some innovation solutions to circumventing the problem of savings inertia - with Save More Tomorrow schemes. These schemes aim to ensure that people never have to cut their spending in order to save more, and have seen savings rates at some participating companies quadruple 12. These simple schemes allow individuals to pre-elect a percentage of any future pay increases for investment into their pension pot. This means that as salaries increase, savings are increased automatically and savers don t have to take the difficult decision of where and how to cut their spending. This could easily be replicated in the UK under the auto-enrolment scheme by starting at the minimum auto-enrolment rate with individuals gradually saving more each time they receive a pay rise. This will also help to address the issue of affordability of pensions to new entrants to the market place - many of whom are likely to be saving for a first home and/or paying off student loans. By the time employees reached 30 or over, they would be at significantly higher contribution rates, but it would have been considerably less painful on the way. This would also address the problem of the auto-enrolment cliff between September 2017 and October At this point, individual auto-enrolment contributions are due to rise five-fold from 0.8% to 4%. This is a substantial increase, and one that new entrants to the workforce will need to save from day one. Replacing this cliff with an auto-escalation / save more tomorrow scheme 8 ONS Survey as above. 9 TISA response to HMT Strengthening the Incentive to Save consultation 10 ONS Occupational Schemes Survey 2014 shows that the average total contribution rate was 20.9% of pensionable earnings 5.2% for members and 15.8 for employers. 11 BlackRock Investor Pulse Survey UK, FT, Save more tomorrow gives pensions a boost, 8th January

7 would enable contributions to increase gradually, and help avoid this shock for both current and new savers alike. We recommend aligning this change of approach with the pension simplifications proposed. This relatively simple change in the way that corporates approach their schemes could facilitate a seachange in the pension outcomes for millions. Of course, the approach is not limited to corporate schemes, but would also be relatively easy to facilitate with personal pension portfolios. We urge the Government, companies and all advisers constructing personal or corporate pensions to embed these automatic rises into their schemes. 3. Ensure the long-term stability of the system There has been much commentary on the relative attractiveness of ISAs over pensions as a savings vehicle. This has much to do with the relative simplicity and attractiveness of the ISA and a long-term commitment by successive governments to maintain the simplicity and transparency of the ISA as a savings product. The frequent changes to the UK pensions regime, whether in terms of annual allowance, tax relief, changes to drawdown, however necessary or well-intentioned, have not been accompanied by clear long-term messaging. The rate and speed of change causes uncertainty. The rules are still convoluted - each change brings an additional layer of complexity to negotiate that may continue to deter potential investors. As people take more individual responsibility for their retirement, it is vital the system is simple and transparent. More than half of Britons13, said they would be encouraged to save more if the Government provided a stable pensions system, and circa one in five (19%) supported the introduction of a Savings Minister tasked with protecting the interests of savers. Our recommendation for an Office of Pensions Responsibility, supporting industry calls for a Savings Minister, provides an ideal opportunity to develop short, medium and long-term projections to underpin consistent government policy Office of Pensions Responsibility The combination of frequent change and complex rules complicates decision-making process and disincentivises individuals from saving for retirement through pensions. Retirement savings reform is too important to be looked at on a piecemeal basis. It is critical that the whole body of pension reform to date is underpinned by a clear long-term strategy that can last through successive governments. A 29 year old today expecting to retire in 40 years time at 69 can expect to live through eight different governments. To encourage people to save sufficiently early into their pensions there is a pressing need for an institutional framework that provides pensions certainty, and ensures that short-term budgetary or political constraints do not erode the longterm sustainability and adequacy of pensions as a vehicle for saving for retirement. The recent appointment of a new minister for pensions shows a welcome commitment on the part of policymakers to the issue of long-term saving. We believe the Government might now go one step further, with the appointment of a Savings Minister, or, better still, the creation of an independent, apolitical post the Office of Pensions Responsibility. This role would be designed specifically (i) to champion and promote a savings culture across the UK and (ii) to provide independent data and projections on what proposed tax or regulatory changes would mean for the sustainability of the pensions system in the short, medium and long term. We believe it would not increase bureaucracy, but would act as a way of streamlining the current system and depoliticising it, removing the habit of successive governments to tinker with the rules according to their short-term priorities. The Office of Pensions Responsibility could review the whole system, and also look at the unintended consequences for savers of introducing new legislation across government departments (e.g. Treasury, Cabinet Office, Department of Work 13 BlackRock Investor Pulse Survey UK,

8 and Pensions, Department of Communities and Local Government, Department of Business Innovation and Skills). Encourage a holistic view of retirement savings through effective education and guidance Individuals saving for retirement are likely to have more than one type of retirement pot (as well as other sources of income, such as home equity and state pension entitlement under the triple lock). They think of their nest egg as a whole, and focus less on the individual pot. While pensions are less well understood than ISAs, we believe the way forward is not to convert existing pensions into ISAs - especially after the immense effort of education that has taken place on auto-enrolment. There will be a greater impact if individuals are able to access holistic financial advice across all their assets when planning for retirement so they have a full view of their financial assets. In this respect we welcome HM Treasury s and the FCA s joint initiative to launch the Financial Advice Market Review, and hope that the outcome of the review will be to facilitate the provision of advice on retirement savings across all sources of potential income and recommend focussing on whether there should be a middle way for more limited advice. We believe such an option could assist savers in making core decisions about their retirement, especially if designed around recent technological developments. We suggest that effective delivery requires clear and engaging digital communications, supporting interpersonal services (predominantly telephonebased support with some online direct communication). Effective support and guidance is the lynchpin of new pensions freedoms. Impartial guidance standards that fully integrate the principles of treating customers fairly, kitemarked by an independent body, could provide a valuable adjunct to the third party support provided by Pensions Wise. Impartial standards would have the important benefit of providing consistent levels of guidance to savers. It could also form the basis of offering providers safe harbours by limiting potential liability for those who meet these impartial guidance standards. 4. Maintain employer support for pensions Maintain incentives for employers to contribute to workplace pensions Employers are responsible for much of the administrative burden of pension provision for the Government, such as by collecting contributions and making additional contributions. This engagement is significant in terms of the long-term sustainability and integrity of the pensions system. In addition, the financial incentives for employers to contribute should be retained, as matching employer contributions funded through NIC reliefs are a valuable benefit for individuals, and will provide material support for individuals to reach an adequate savings rate. We also believe that employer national insurance relief should continue to apply to employer pension contributions, and that employee tax relief on employer pension contributions should remain as it is now. While reforming higher rate tax reliefs, ensure senior staff retain a stake in the pensions system Recent budget announcements restricting the lifetime allowance and annual contributions that attract tax relief from higher rate earners run the risk of disengagement from the pensions system by higher rate earners. Many DC pension schemes rely on the significant level of contributions from higher and additional rate earners to develop scale. It would be counterproductive to the overall running of the scheme if these earners are disincentivised from making contributions to their schemes. As mentioned above we recommend moving to a single sustainable annual allowance, allowing the removal of the annual lifetime allowance. Higher rate tax earners are typically higher rate earners for only a relatively small proportion of their total working life, and it would run counter to the aim of a consistent long-term pensions policy to take them out of the pensions system for part of their life. The opportunity to make increased pension contributions later in life can help to balance lower rates of savings earlier in life. Higher rate earners are also more likely to be involved in decision-taking over a firm s pension 8

9 policy and retirement benefits. If key individuals themselves have no stake in their firm s pension policy, then the risk of badly designed workplace pension provision increases. 5. Promote a longer-term investment culture The design of automatic enrolment incentivises individuals saving in pension funds not to put their holdings in cash. This helps to protect them against the risk of under-saving, and inflation reducing the real value of their savings. The reliance on default investment strategies is crucial in mitigating individual s inherent investment risk-aversion. From an investment perspective it is essential that individuals have access to a wide range of appropriate asset classes in which to invest their savings and build an income in retirement. Long-term investment is the way to generate long-term consistent growth for the economy, and pension fund investment forms the bedrock of this wider long-term funding for the economy. By definition pension liabilities are long-term and individuals should therefore be incentivised to take a long-term investment view. The pensions regime should be designed to provide savers with a form of illiquidity premium, to reward those who lock away money for future retirement needs. Any reform to tax incentives should strengthen, not weaken, the link between pensions and longterm investment. Any change that makes short-term investment or cash holdings more attractive would be to the detriment of both individuals and the long-term health of the economy. There is a real and pressing need for investment in long-term assets such as infrastructure, and we note increasing calls for public sector DB schemes to combine assets to invest in this area. However, within private sector DC pensions the very construct required to facilitate individual investment decision making forces investment to be channelled towards investments in more liquid instruments traded on public markets. As part of our call for an Office of Pensions Responsibility and Savings Minister, we call for further work on how a wider section of the population could be incentivised to invest more in longer-term assets. This requires innovative thinking. We make some initial suggestions and would be delighted to contribute further to Government thinking in this area: It would be beneficial to review the investment rules to encourage investment in longer-term assets. The liability matching benefits of longer-term assets, such as investment as infrastructure, come with a number of associated structural issues. These are largely buy and hold assets and schemes would need to maintain a limit on the total percentage of illiquid assets they hold, say around 20%. Schemes will also need a detailed liquidity management policy, such as that required under the Alternative Investment Funds Management Directive (AIFMD), to cover the effect of transfers out of the scheme, which might generate greater concentration in illiquid assets. This could be effectively mitigated by the use of mechanisms such as side pockets to facilitate secondary market transfers of the underlying assets. This would need to be accompanied by clear messaging to members that transfers during the accumulation period could be phased. Further work on the liability of trustees and IGCs would also be needed, to provide them with appropriate safe harbours if they put in place longer-term investment strategies of this nature as well as further guidance on the inclusion of longer-term assets in the assessment of value for money they are required to make. Further work on designing collective DC schemes could be beneficial such as the work conducted by NEST earlier this year (the idea of individual ownership engendered by DC is very much welcome, however we also need to bridge the long-term challenge and pooling assets could be a very efficient way of achieving this). We also recommend a new way of incentivising long-term saving for future generations, by harnessing the power of the eighth wonder of the world - compound interest over an individual s full life time, so that by the time adults start to enter the workplace they have already built up a pot which sets them well on the road for financial independence in later life. There are a number of ways this could be achieved, e.g. by government contributions to the Junior ISA with an element of lock-up so that government contributions made early in life 9

10 which when compounded over years could help to reduce reliance on the State later in life. We would welcome any further discussion on any of the points that we have raised. Yours faithfully, Paul Bucksey BlackRock Head of Defined Contribution, UK Martin Parkes BlackRock Public Policy, EMEA Tony Stenning BlackRock Head of Retail, UK 10

11 Responses to individual questions 1) To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension? Individuals saving for retirement have a number of fragmented sources of capital and income. These include the state pension, and in the private sector also Defined Benefit (DB) pensions, Defined Contribution (DC) pensions, ISAs and property. Understanding how to combine all these sources of income is complex and challenging for individuals. For many years primary responsibility for planning for retirement lay between the state and employers. The state pension and employer run schemes still remain a considerable source of retirement income. The system is being rebalanced towards a greater take-up of DC pensions, which requires greater responsibility from the employee. For decades, many individuals have been sheltered from financial complexity by their employers and it will take many years to build up the level of financial education and engagement where individuals are empowered to take full responsibility for their own financial planning. While simplifying the tax treatment of DC pensions could provide some benefits, it does not address the more challenging issue that unless individuals have access to sophisticated financial advice and planning they are ill equipped to have an understanding of their total personal assets. Inertia, and the complexity of the current savings framework, are also powerful barriers to effective individual engagement. Recent changes such as pensions freedoms are encouraging greater engagement by individuals with their retirement savings, but we believe the three areas that will have most impact are: Development of tools by both government and industry about income expectations both from government and industry on how much income the state pension is expected to provide and what income various sizes of pension pot are expected to deliver. The general public would benefit greatly from generic guidance that includes how much saving for a typical goal might be appropriate. It is essential to deliver online tools covering topics such as longevity, living costs and investment in this process. The ability to access holistic financial advice which allows individuals to combine all their various sources of potential income, not only at retirement but well in advance and take informed decisions. Financial advisers can better serve their clients needs if they can provide advice with respect to all of their clients assets, without the avoidable burden of complex, conflicting or overlapping regulatory requirements. We strongly support the aims of the Financial Advice Market Review as a key plank in providing individuals from the tool kit they need to make effective decisions. 14 The ability to pool information about different accounts in a single place, through the introduction of a digital passport. 15 We believe that DC solutions are a key component in delivering a sustainable income in retirement. Providing a more simplified tax treatment is only one part of ensuring that DC pensions are designed to: Meet a wider range of consumer needs, such as providing a predictable level of retirement income with various draw down options Keep generating returns as savings deplete over time Be easily understood and transparent Be cost efficient Provide online guidance throughout retirement We also underline the continued importance of offering default solutions designed to meet the needs of the majority of savers in both the accumulation and decumulation phases. As much as we support the need for tools to assist individuals in planning for retirement, a significant 14 Financial Advice Market Review August TSIP, Saving our Financial Future,

12 proportion of the population will only have limited engagement. Where savers do not make, or delay making, decisions regarding their savings on retirement the default solution will have to operate in the decumulation phase in effect this would be the new default retirement option unless a saver makes an active decision to tailor their retirement income. 2) Do respondents believe that a simpler system is likely to result in greater engagement with pension saving? If so, how could the system be simplified to strengthen the incentive for individuals to save into a pension? While we believe that a simpler tax could assist in making it easier to engage with individuals, there are two key issues which should be explored framing an individual s retirement needs, and compulsory saving for retirement. Framing an individual s retirement needs In our view it is essential to frame an individual s retirement needs. The shift from DB to DC has placed the three dimensions of retirement investing firmly on the shoulders of participants: saving, asset allocation 16, and the transition into retirement spending. Today, most individuals equate saving for retirement with accumulating a pot of money for retirement, and using this either as a cash lump sum or purchasing an annuity. The transition of accumulated savings instead into an efficient income stream needs to be addressed. This is particularly important as the mechanics of this transition and the benefits of potential solutions are poorly understood by most participants (and indeed are not catered for in traditional product designs). Yet research we have conducted in the US has shown that members with pension schemes that define the income benefit, or who have a high degree of certainty about their accumulated savings ability to generate income, believe they are more prepared for retirement. 17 What most individuals need is a reliable form of income to fund retirement spending, specifically, to cover expenses such as housing, food, heating and leisure costs, etc. Annuitisation provided certainty in this regard, but with little or no flexibility of income over time. Wealth accumulation is largely a function of savings rate and market returns. Retirement spending, or rather the obligations that require spending, generally has no relationship to market returns it is difficult to decrease spending in years when markets are falling because there is an effective spending floor, unless specific advice is taken on reducing expenses in adverse market conditions. In the retirement savings construct, individuals seek to fund a set of spending obligations that in most cases have no analogy in the investor s asset portfolio. The key, therefore, is for product providers to combine product design with features to help members understand the connection between their current retirement savings and their future spending power, to help them protect their future income potential, and help manage the impact of market volatility on their portfolio s ability to provide such income. This should ultimately benefit participants in that they can achieve more clarity about their ability to meet their spending obligations in retirement. Compulsory savings We welcome steps taken in recent years to ensure that UK citizens can meet the challenge of increasing longevity with confidence. In particular raising the retirement age, introducing autoenrolment and the establishment of NEST have all contributed to improving the UK pensions system sustainability in the long term. In particular we welcome the effect that auto-enrolment has had on reducing the decline in pensions savings. Significant as they are, these steps are not enough. There is still too much risk that individuals are not saving sufficiently if they remain enrolled at the default contribution rates or indeed that 16 Dalbar Quantitative Analysis of Investor Behaviour, According to the BlackRock 2012 Annual Retirement Survey, participants with a DB plan are more likely to report that they are prepared for (66%) and will have enough money to (62%) retire. 12

13 they will opt out of savings entirely. To achieve an individual s long-term goals of retirement income we need people to save more and save earlier. We therefore recommend making an appropriate level of retirement savings compulsory, without the opportunity to opt out, at a rate that will provide a sustainable retirement income. We acknowledge that this is not a move that can happen overnight. We believe there is much opportunity for using auto-escalation techniques such as the Save More Tomorrow. We recommend building on the insights from the behavioural finance experts in this areas such as those from The Behavioural Insights Team. 18 As with auto-enrolment, we would encourage the Government to find a politically neutral option acceptable to all parties, in order to be consistent over the long term, rather than changing with each change of government. Workers coming into the workforce in their 20s may find it challenging to meet a very high contribution rate initially, due to challenges such as housing costs and repayment of student loans. Auto-escalation techniques could be used to ensure that the amount and contribution and rate of increase could be aligned to a number of factors such as age, time to retirement and affordability so that they could gradually reach the right level of savings. By way of benchmarking an appropriate savings rate, to generate an income replacement rate equivalent to that under direct benefit schemes, an individual would need to contribute sums in excess of least 20% of their salary. 3) Would an alternative system allow individuals to take greater personal responsibility for saving an adequate amount for retirement, particularly in the context of the shift to defined contribution pensions? As mentioned in our response to the previous questions we believe that the primary objective of an alternative system should be to require compulsory savings building on auto-enrolment to require individuals to save to a sufficient level so that they can enjoy a dignified retirement with an adequate amount of retirement income. This should be supplemented by continued focus on default savings options, more effective use of tax reliefs and an ongoing focus on education. There should also be a wider debate on the interaction between housing policy and retirement savings. Designing default savings options As well driving greater personal responsibility we should not underestimate the challenge and time it will take for individuals to start engaging more closely with retirement planning. Building in a default savings mechanisms is a necessary complement to compulsory savings. The role played by default funds such as those provided by NEST and other providers is key, especially for the average investor with little knowledge of finance and investments. When comparing initiatives taken in other jurisdiction faced with similar challenges to encourage greater engagement with pensions savings, we note some useful experience in the US. The US Pension Protection Act of 2006 (PPA) 19 is a good example of a fundamental change that achieved these objectives. Through the PPA, Congress and the Department of Labor (DoL) enacted legislation and implemented regulations designed to make it simple to increase savings and improve investment of those savings. 20 The PPA provided for automatic enrolment, automatic escalation and qualified default investment alternatives (QDIA), which were intended to collectively improve retirement outcomes. In particular, by adopting asset allocation products as QDIAs, the PPA addressed the problem that the average investor, with little knowledge of finance and investments, had overwhelming allocations to company stock and conservative fixed income investments and did not change allocations over time. 21 The DoL recognized that participants 18 The Behavioural Insights Team, EAST: Four simple ways to apply behavioural insights, Pension Protection Act, Pub. L. No , 120 Stat. 780 (2006). 20 Notice of Proposed Rulemaking - Default Investment Alternatives under Participant Directed Individual Account Plans, 71 Fed. Reg , (Sept. 27, 2006) Fed. Reg. at ; See also William J. Wiatrowski, 401(k) Plans Move Away from Employer Stock as Investment Vehicle, Bureau of Labor Statistics, Monthly Labor Review (November 2008), available at 13

14 need help in allocating their savings across asset classes to achieve a better outcome and, by establishing asset allocation products as a safe harbour, it provided that help. Simplifying tax reliefs Secondly, we support considering a more streamlined use of tax reliefs under the current system, targeting tax reliefs at lower and middle income earners who need the most support Payroll implications of such a change would also need to be taken into account. The result should be a cleaner way of limiting the amount of tax relief paid to higher rate earners, without disincentivising them from investing in pensions. We would also recommend rebranding tax reliefs, as this is a concept that is not well understood. Instead, we suggest referring to this as a government matching contribution into an individual s pension. Expressing the matching as a simple ratio or message such as for every 100 pounds an individual contributes, the government puts in an additional x. We have referenced a number of studies in our introductory section 1 which set out how this could work in more detail. We also support an annual cap on the amount of savings that can be saved into DC schemes, and abolishing the lifetime allowance. This would create more certainty for those who might otherwise refrain from saving into a pension due to concerns around exceeding limits on the value of their savings. Similar to ISAs, this would be provided on a use it or lose it basis. The amount of the annual contribution provides the Treasury with a mechanism to encourage or limit savings. Consider the implications of housing Psychologically many individuals put securing a place on the housing ladder well before savings for a pension. This has the effect of delaying the time when an individual starts saving for retirement and/or encourages the view that my house is my pension. To counter this, we would welcome investigation of the benefits of allowing an early draw down from an individual s pension pot to fund the first time purchase of a property. There are similar precedents in other pension regulation in the world such as those in Singapore and the US. If permitted, we would recommend limiting access rights to a one-off partial draw down. Continued focus on education These measures will need to be accompanied by a significant focus on education. Compulsion simplifies the first key step individuals have to take. It will then need to be accompanied by key messages around respective contributions from individual, employer and government to emphasise the value of matched contributions. This would build on the presentations used in auto-enrolment showing how matching contributions work. We would minimise references to the use of percentages, as these are often not as well understood as monetary figures. 4) Would an alternative system allow individuals to plan better for how they use their savings in retirement? One of the key challenges individuals currently face is a lack of understanding of how much income their retirement income will be worth. We suggest that simple metrics could be useful, such as how much income a pot of 100,000, 250,00, 500,000 would buy you now, and in say 10 years time. Given the benefits of compounding over time, we strongly recommend using messages that show the likely income from a pound saved when an individual is in their 20s, their 30s and 40s. 22 The scale of changes proposed in the 2014 Budget calls for a fundamental rethink in the way that savers are supported, so they can make informed decisions. In our view, the logical and most suitable bedrock of this approach would be the provision of free and comprehensive guidance programmes, where the dominant features would be clear and engaging digital communications (online and mobile based technologies tools, simple modelers, informative content and the 22 Scottish Widows press comment, 7 September 2015, 14

15 provision of a retirement dashboard enabling members to track their investment, income and glide path needs) with supporting interpersonal services (predominantly telephone-based support with some online direct communication). The core principles of guidance by pension providers should involve: (1) Suitability for the majority of individual savers (2) Cost effectiveness (3) Transparency of the guidance outcome (in particular the default option) On the first two points, we believe it is important to strike a balance between addressing the needs of the widest possible audience and doing so without increasing the cost of service provision which ultimately reduces investor returns. This requires considering the relative importance of DC savings by different cohorts of investors within the population. The lowest earners, for whom current State Pension benefits alone are likely to lead to a high replacement income, will likely continue to favour taking their DC savings as a lump sum the default decumulation into cash is therefore likely to remain appropriate. At the other extreme, there is likely to be a proportion of the highest earners who will have other sources of income and are unlikely to rely solely on replacement incomes from DC pensions. The core target audience is therefore a wide range of earners between these extremes, for whom DC pensions are likely to be their largest savings assets and for whom simply annuitising would result in significantly lower replacement incomes upon retirement than they would expect. Conversely, if they draw down capital on retirement they would be exposed significantly to the longevity risk of outliving their savings. Technology and scale will be central to providing tools to address the needs of this audience. On the third point, it is important for providers to be transparent on how money will be invested in the absence of instruction from the investor (i.e. default options). This is particularly important, as scalable guidance cannot cover every possible circumstance but will seek to be appropriate for most instances such as the default options. Individuals can then take the decision as to whether it is worthwhile to pay for further advice from an independent financial adviser or other qualified professional. We agree that face-to-face financial advice (as opposed to mere guidance) will have a place in those situations where personal financial affairs and taxation implications are more complex, and for those that specifically wish to access and pay for such support. In the savings accumulation phase we see a place for workplace access to other forms of support ( face to faces ), e.g. onsite presentations to larger groups of employees, webinars via employer portals etc. as part of an overall provider to employer support programmes. However, employer engagement with postretirees will not be a feature in most cases and hence achieving direct engagement between provider and individual will be key to providing guidance during the post-retirement phase. We also note the need to ensure that financial planning for retirement takes into account all potential sources of income. The schematic below shows the four key sources of income. 15

16 DB/DC /personal pensions State pension Indivdual retirement income ISAs, stocks, shares, deposits Other souces such as lifetime mortgages Currently these various sources of income are generally treated differently in terms of advice. Moving to a fully investor-centred advice model would allow individuals to access a holistic view of their asset and potential income. We recognise that some of these areas call for very specialist advice and are designed to have very specific consumer protections in mind, such as the regime for lifetime mortgages which has proved to be robust. There does however need to be a way of combining all this information in a way which allows an individual to ask key questions such as, How much money can I expect to live on in retirement? and What do I need to do to save more in retirement?. 5) Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated? No. In our view this will generate significant operational complexity. It will be counterproductive to change the tax treatment for existing schemes. If such a change were applied, it would inevitably lead to a segregation of pre and post implementation pension pots, or a requirements to close old pots and reopen them under a new name. Individuals would then have to understand the impact of two different tax treatments on their income expectations which would be even more confusing than under the current system. Administrators would also have to run dual systems (i) for contributions made under the existing system until the time of change over and (ii) in respect of new contributions after the change of tax treatment. This would be costly, and discriminate against existing participants in the market who would be obliged to maintain legacy systems without the benefits of economies of scale. Taken together, this runs counter to the aim of reducing fragmentation and encouraging simplification of pensions. 6) What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How could these best be overcome? There are significant educational and operational challenges in moving from an EET basis to a TEE basis of taxation. There are significant downsides in a wholescale change to a TEE system. Regardless of what future changes are made existing schemes will have to continue to operate on an EET basis. This means operating two systems concurrently. The operational complexity and confusion to savers and providers of running two systems in parallel would be significant. In particular there would be a significant increase in the expense of educating customers about what they can and can t do 16

17 While a TEE system may be perceived as simpler in practice, the fact is that the vast majority of DB and DC pots would be legacy business, and have to be administered on an EET basis for decades to come. We have contributed to the work of the NAPF to identify the cost implications this would entail, and refer to response to this consultation. In addition, these changes would create a large pool of closed legacy providers who would not be able to benefit from the economies of scale from new and increased contributions without the incentives to innovate and reduce administration costs to members. It is likely that employers would also suffer unnecessary additional cost in supporting multiple systems and in explaining the effect of different entitlements to their employees. Without a strong commitment over many years from successive governments to maintain a TEE basis for new contributions, many savers will have concerns that larger pots built up in the future will be subject to tax on drawdown at some future date. This would provide the type of disincentive to savings that Government is keen to avoid. 7) How should employer pension contributions be treated under any reform of pensions tax relief? We believe it is essential to continue to incentivise employers to make basic provision for all staff. Employer contributions represent a significant incentive to savers, and cut the cost to the Treasury. Employers are responsible for much of the administrative burden of pension provision for the Government such as by collecting contributions and making additional contributions. This engagement is significant in terms of the long-term sustainability and integrity of the pensions system. In addition, the financial incentives for employers to contribute should be retained as matching employer contributions are a valuable benefit for individuals and will provide material support for individuals to reach an adequate savings rate. We also believe that employer national insurance relief should continue to apply to employer pension contributions and employee tax relief on employer pension contributions should remain as it is now. 8) How can the government make sure that any reform of pensions tax relief is sustainable for the future? We welcome the focus that the Government has brought to ensuring that the UK s retirement system meets the needs of future generations without imposing undue burdens on the budget. Unlike the ISA regime where the central framework has remained stable with various welcome additions such as passing on ISA on inheritance, there is a perception that the pension system is unstable which brings a consequential lack of trust. While some significant changes need to be brought in, this must be done in a way that provides certainty and consistency. We refer to our recommendations for an Office of Pensions Responsibility in Point 3 of our general recommendations. There also needs to be a clear cost benefit analysis of the operational complexity and expense of proposed changes to ensure that operational inefficiency doesn t outweigh the benefit of any incentives offered. We appreciate the opportunity to address and comment on the issues raised by the consultation and we will continue to work with HM Treasury on any specific issues raised in our response. 17