This week was Budget week. The upgrade to the growth and public finances forecasts were both minor and largely expected. Indeed, they reinforce our conviction that there’s too much debt. Similarly, the tax cuts for bingo, beer and scotch whisky signify nothing more that the election campaign has started early. However, the changes to savings and pensions “marked a genuine departure”. Even our normally sceptical editor John Stepek can’t help but admit that, “if you’re a saver or an investor, then believe it or not, this was a great Budget”.
The first change is that the Individual Savings Account (Isa) allowance is going up to £15,000 a year. What’s more “you’ll be able to fill that as you wish”. At the same time “the range of investments is being widened”. This is good news because Isas “are more flexible than pensions, and a lot more transparent”. Indeed, the increased limits make them “a very feasible alternative to pensions for the vast majority of people”.
Of course, the Budget also “made pensions more attractive”. While annuities have technically “not been compulsory since 2011”, most people end up buying one when they retire. However, as well as taking a 25% lump sum at age 55, you can now “take the rest too, or a bit of the rest, at your marginal tax rate, rather than the 55% rate”. Overall, “people with pension pots will have a lot more options when they retire”.
John cautions that, “these changes are not going to create a massive retirement pot for you if you don’t already have one”. However, “if you are trying to save hard for your future, then these changes give you a lot more freedom as to how you go about it”. Obviously “some people will blow through their pension pots more rapidly than they would have”. However, annuity providers are now “going to be forced to work harder for our money”. Just as the Retail Distribution Review, “demonstrated the benefits of introducing tougher competition, more transparency”, this “could do the same for annuities”.
Of course, “tossing a bone” to savers and pensioners at a time of rock-bottom interest rates “is a shrewd move”. He’s also worried that these changes may enable “the government to ditch costly tax reliefs on pensions”. At the same time “if more people take their pension pots as a lump sum, they’ll be paying more tax”. Even so, this budget is good for “anyone who wants to take and keep control of their own finances”.
Merryn responds to the changes’ critics
Our editor-in-chief, Merryn Somerset Webb, is a big fan of the changes, especially the ability of people to take their whole pension in cash. She thinks that it is “really fantastic news for long-term savers”. However, “a good many people found an immediate problem with it”. Their basic argument is that this increased freedom “smacks of moral hazard”. Indeed, they warn that “people will get their pension tax breaks, grab their money at 55, spend the lot and then expect the taxpayer to pick up all their bills from then on in”.
In her view, such arguments are “complete nonsense”. First, “anyone who has saved up a reasonable amount in their pension would have to pay a whopping amount of tax if they took it all at once”. What’s more, “those who hold pensions aren’t idiots, likely to turn from diligent believers in the future to spendthrift short-termers on the turn of 55”. She also points out that “leaving your money inside your pension and taking it out as you need it means that your investments continue to roll up income tax and capital gains tax-free”.
Finally, the compulsory guidance means that, “everyone but the truly desperate (or very unwell) is going to choose to enter flexible drawdown – keeping their money in a pension wrapper and using it to create an income”. Indeed, this will be more attractive since “the new system won’t limit the amount you can take out every year in the same way the current one does”. Overall, for most people, “flexible drawdown and a new pension independence is about to become the norm”. In the future pensions will become “nothing more complicated than a long term tax-efficient savings account”.
User ‘Tax Slave’ agrees with her: “Right on Merryn”. In his view the changes are “a refreshing and sensible move away from the nanny state, and may get people back to being interested in saving for their own future”.
Want to ask Merryn some questions? She will be speaking at our MoneyWeek Conference on Friday, 2 May. If you book now you can get a discount of 22%, bringing the cost down to just £217.
Why you should care about employee ownership
David Thornton, who writes The Penny Sleuth, used to think that “there’s no simple formula” for finding out whether companies are well governed. However, he’s recently “discovered that quoted companies with above-average levels of employee ownership have outperformed significantly over a long period”. Indeed, there’s a special index called FTSE Employee Ownership Index (EOI), which “tracks about 70 UK companies where employees own more than 3% of the shares”. Last year it returned 53.3% against 20.8 for the FTSE. Indeed, “you would have earned roughly 12 times the return of the All Share over the last 21 years”.
In his view “employee-ownership makes sense”. Firstly, “owner-workers are likely to contribute more in terms of ideas and effort”. They should also “be better informed about the business and have a more complete picture of what the company is trying to do”. Of course, “co-ownership needs to go deeper than employees having a few shares; they need to be fully engaged with the business”. The evidence suggests that, “the policy also fosters an atmosphere of shared responsibility”. Indeed, “I’ve heard examples of workers telling absentee colleagues that they’re letting the side down”.
David Thornton admits that, “the EOI is not perfect”. Indeed, “there might well be issues about the robustness of the methodology behind it”. Another problem is that “EOI’s two starting points of 1992 and 2002 are flattering since they marked significant lows in small-stock valuations”. However, “even if we have a healthy scepticism about the scale of these numbers, there does seem to be a seriously material effect going on”. Overall, “I definitely think it’s worth paying attention to employee ownership. In future, David is going to ask all the companies he talks to about their levels of employee ownership and engagement.
Interestingly, “this interest in employee-ownership has culminated in the launch of an investment company – Capital for Colleagues”. It aims “to invest in privately-held businesses where there is a “meaningful level” of ownership amongst the workforce”. The fund manager also insists that, “management have to treat their co-owners as just that, fellow shareholders in the business”. Thornton will “certainly be interested in seeing if its returns emulate those breath-taking Employee Ownership Index numbers quoted above”.
Crimea crisis show why you should diversify
The other big event of the week was Crimea’s “decision” to rejoin Russia. As John Stepek points out, “the presence of Russian soldiers, and a general sense of foregone conclusion might have had some influence on the sheer scale of the 95%-odd vote in favour”. However, the big question is “what does it mean for investors?”
As John says, “investing on the basis of headlines is not a winning strategy”. However, “there’s nothing wrong with wanting to understand a situation better”. Despite Crimea’s closeness to Russia, and the fact that the population is “clearly more pro-Russian than the rest of Ukraine”, it still means that, “you don’t just march into a country (or semi-autonomous region), declare a referendum, then annex it”. This means, “it’s tricky for the rest of the world to just sit there and let Russia get away with this without causing at least a bit of a rumpus about the whole thing”.
However, it’s important to note that “Russia accounts for a tiny percentage of the global financial system”. It also “holds relatively few US Treasuries”. This means that, the Russian financial system does not “represent a major systemic risk to the global economy or Western banks”. Even though Russia “is a key supplier of gas to both Ukraine and the EU” an economic war would be “a case of short-term pain for Europe, long-term pain for Russia”.
On the other hand, “autocracies like Russia” don’t always behave in economically rational ways. “Maybe Russia is happy to suck up some economic pain in exchange for getting one over on the West”. If there are disturbances in eastern Ukraine “it might feel emboldened to just keep on going”. This means that, “we could end up with a much stickier situation than ‘rational’, economics-centred analysis would suggest”. As result, “we suggest you have a bit of your portfolio (5%-10%) in gold, as a safeguard against situations like this”.
Chances are that this will be resolved in a fairly low-key way. However, “if things escalate – well, that’s why you have a diversified portfolio”.
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