Intergenerational fairness: How to bridge the pensions gap

The Association of Consulting Actuaries has proposed a 'national flexible ISA' and tax reform to improve intergenerational fairness. Kim Kaveh looks at how these would work

It is arguable that changes to pension policy should be made because the ongoing shift from defined benefit (DB) to defined contribution (DC) pensions means younger generations may not enjoy a similar retirement to older generations.

In November last year, the Intergenerational Commission published a report named, As good as it gets? The adequacy of retirement income for current and future generations of pensioners, which seeks solutions to the perceived growing gap in income outcomes across different generations.

It argues younger generations’ prospects are particularly uncertain given both the big shifts in pensions policy currently in train and the fiscal costs associated with rising longevity and the baby boomer generation entering retirement.

In response to its report, the Association of Consulting Actuaries (ACA) wrote a letter to the Commission in December, challenging its views on intergenerational fairness in pensions.

It said its evidence does not support the conclusion that, “overall, future pensioners look set to experience similar levels of earnings replacement adequacy to recent retirees”.

The ACA has proposed greater flexibility in how retirement savings can be used is key to renew a ‘social contract’ between generations. This looks to pension, saving and tax arrangements offering a fair balance across the generations, so people of all ages feel they are not being disadvantaged by the pensions system.

The ACA has suggested three policy proposals in response to the commission’s consultation.

National Flexible ISA

It first said there should be a ‘national flexible ISA’ to allow withdrawals of up to £30,000 from pension saving in the accumulation phase – to fund house deposits or potentially other limited spending needs.

According to the trade body, this complements the flexibility of tax-free cash lump sums and withdrawals under Freedom and Choice in the decumulation phase, can be taxed consistently, and offered through existing occupational DC schemes (which the relatively complex Lifetime ISA (LISA) is unable to do), without the need for extensive new legislation.

It added to ensure pension saving is restored after withdrawals, additional minimum employee contributions could be mandated for those who flexibly access cash in this way.

It is important to note that a similar proposal arguing the need for an additional ISA has already been put forward to the government.

Centre for Policy Studies research fellow Michael Johnson, who wrote out the LISA proposals before they came into effect in April last year for then-chancellor George Osborne, has been pushing for a ‘workplace ISA’ (WISA) to compliment the LISA.

His pensions and savings manifesto published in April last year said the ‘workplace ISA’, included within the AE legislation, would be specifically to accommodate employer contributions made under AE, and taxed at the employee’s marginal rate.

However, these would be accompanied by the same 25% Treasury bonus as the LISA, which came into force in April 2017 (economically equivalent to basic rate tax relief on pensions’ contributions). Withdrawals from the ‘workplace ISA’ would not be permitted until the age of 60, but thereafter they would be tax-free.

Johnson says it looks like the ACA are moving towards his agenda.

“The ACA has phrased the types of proposals I laid out on this subject, avoiding the ‘workplace ISA’  language, and essentially what they’re proposing is the LISA, and the next steps we might take with LISA already does – it provides access to savings before the age of 55, for the purpose of purchasing your first home.”

He adds: “What they’re struggling with is how the occupational pension world and the AE framework interacts with the LISA structure.”

However, Hargreaves Lansdown senior pension analyst Nathan Long argues a ‘national flexible ISA’ is probably not the way to go.

“At the moment there are lots of extra ISAs being born, and actually what we’re doing is taking what was a very simple product in the ISA which was very popular with savers because of its simplicity.

“Now, all of a sudden we’ve got the risk of people not knowing where to save, whereas before a member could say, ‘ah, I’ve got an ISA, I’m either going to save in cash or save in the stock market, so it’s pretty easy to know where my first port of call is’.”

Nonetheless, if a ‘national flexible ISA’ were introduced, there should arguably be additional rules on the maximum amount a member can withdraw.

Long reiterates this and adds: “£30,000 is reasonable if it was half of the member’s pension plan. For example, members can only take £30,000 if they have £60,000 in their pot, as many people do not have much more than that in savings.”

Tax reform

The ACA also proposed changes to pensions tax reform. It argued in 2015/16, £38.2bn was received in pensions tax relief, with around two-thirds going to the 17% of the population paying higher or additional rate tax (and most likely to be towards the older end of the age spectrum).

It added any of the major tax reform options (ranging from flat-rate relief to pensions ISAs) that have been considered in recent years could result in a saving on this amount and hence achieve a positive intergenerational impact.

Long agrees, saying the 17% figure makes sense, but adds: “However, one of the biggest issues is well over three quarters of the big tax relief figures that we see goes to DB schemes of which no one really enjoys anymore – so that to us seems very out of kilter especially when all the measures that we’ve had to try and trim tax relief, the cost of it has been on DC schemes to the larger extent.”

Baroness Ros Altman is concerned that past generations have caused huge extra costs for employers, and other resources available to younger generations have been reduced.

“I don’t think there is an easy solution to solve intergenerational issues because of the costs provided under the DB system, and had anybody had known what it would have been in advance it wouldn’t have happened.”

She adds there is merit in having the same incentive for everybody and actually getting rid of tax relief because it is too complicated.

She suggests the government introduce the following pension incentives: “So if a member is saving £1 into a pension, the government would add an extra 30p. If a member saves £3 in a pension, the government would put in £1 for free.

“That’s a method that would sell to people, they would understand, and perhaps be the same for everybody, and people could relate to this.”

Retirement expectations

The ACA also suggested realigning retirement expectations to improve retirement outcomes. This would involve helping individuals to make realistic assessments of their retirement expectations so that they can set appropriate savings targets.

According to the Pension and Lifetime Savings Association (PLSA), national retirement income targets are needed to help savers understand whether they are putting away enough money for old age.

It launched a consultation last October to gauge views on how such targets would be adopted, what level they should be set at, and if there should be varying levels depending on socio-economic factors.

Long says this is very sensible. “This makes it very easy to have conversations with people from a very young age on what retirement aspirations might be rather than having to get them to think about what income they might need in retirement.

“Even when you get there, you tend to find most people don’t know how much they’ll need in retirement even when they’ve just finished work and making their decisions. So to have those broad figures is good but I think ultimately it comes down to people taking individual responsibility for their retirement.”

Greater flexibility in how retirement savings are used may be key to ensuring more intergenerational fairness in pensions, and the ACA’s proposals are reasonable. However, it is evident there is a risk that introducing another type of ISA could create yet more confusion for savers.

Making changes to tax reform, particularly tax relief could have a positive integrational impact if it is scrapped or replaced with another incentive. Also, realigning retirement expectations for members by helping them set realistic targets could ensure members have an adequate pot at retirement.