Can you think of a single reason why the UK pensions industry should exist? I’ve thought about it. And I can’t.
Pensions are complicated. Pensions are confusing. Pensions are expensive to administer – for both state and the saver. For all these reasons, they are a licence to print money for too many product providers. Worst of all, they aren’t even much good to most people.
Let’s not forget that pensions are not ‘tax-free’. Instead, all they do is to defer the tax you pay on your cash. If you are a 20% taxpayer now, and will be a 20% taxpayer when you retire, the gain to you in putting money into a pension is pretty minimal: you might get your income tax rebated on the way in, but you’ll pay it back on the way out – when you take the income from it.
You’ll also be taking a bet on your longevity: die too early and annuity prices – the amount you must hand over in exchange for an income for life – will mean you have no hope of getting back what you put in.
Now, you might argue that we must have a pensions industry to enable – and scare people into – saving for future needs. Otherwise, people just won’t save for their old age. But we do, and they still don’t.
More than half of all UK adults make no pension provision at all. This isn’t because people don’t want to save, or even that they can’t afford to save. It isn’t because they are financial illiterates, either. Far from it. It is because they are endlessly bamboozled by an industry that has complexity on its side.
So shift your eyes from the tedious details of pension legislation, clear your brain of worries about cuts to pension tax relief in next month’s Budget, and look instead at individual savings accounts (Isas).
Isas are about as simple as you can get. Everyone gets £10,680 a year to chuck into a fund. They can keep it in cash, or they can invest it in pretty much anything they like. But the key point is that once it’s in, it’s in. And it is tax free – free from the long arm of the taxman until its owner’s death.
No fussing about the tax implications of reinvesting dividends or going over your annual capital gains tax limit. No filling out self-assessment forms to try to claim back the extra 20 or 30 percentage points of income tax that haven’t been automatically rebated, as is the case with pensions. No more worrying that you might have misreported a dividend or two from a small equity holding you aren’t accounting for properly. No meetings with accountants about complicated tax saving devices. No panic about whether to take out 25% cash when you retire, or leave it in and hope for the best. No tax to pay on income in retirement. No need to spend hours wondering what an ‘open-market annuity option’ is before taking whatever rubbish deal was on offer from the first provider. No more jargon about ‘stakeholders’, ‘NEST’, ‘defined benefit’ and ‘salary sacrifice’.
Sounds good, doesn’t it? But here’s the most interesting thing about Isas. We love them: 23 million people in the UK now hold them. That’s out of an adult population of only 36 million. And two-thirds of us who hold them have more than £15,000 invested in them.
So here is what I think we should do: abolish the pension system and increase the annual Isa limit to somewhere around £30,000, with some kind of lifetime contribution limit included too. Make a big deal about how the money comes out entirely tax-free. Not having to pay tax on my income when I am old is an attractive option to me and I bet I am not alone.
Policymakers will argue that is asking for trouble, because people could fritter away their Isa money at any time – and end up dependent on the state.
But I doubt this. If people have saved carefully to finance their retirement, it is hard to imagine them suddenly splurging the lot on retirement. You could, if you felt you had to, insist on everyone keeping an age-dependent minimum amount in their Isa, just in case.
Some might also argue that doing away with pension savings would be a disaster for public finances. But I can’t see why that would be, either. The Treasury could amuse itself with a one-off levy on all pension holdings to convert them into Isas – solving some of our deficit problem at a stroke, and buying a little more time from the sovereign bond markets to sort the rest. This new system would also save all the money the government currently spends on pension tax relief, which should compensate for the lack of income tax being deducted from Isa investments.
• This article was first published in the Financial Times.