Hoping for a break from changes to pensions regulation? Too bad – it looks like more are on the way. At his last budget, Chancellor George Osborne said that (more) “radical change” was possible, change that might make a pension more like an individual savings account (Isa). Pensions and Isas both offer savers tax-efficient ways to save. But they do so slightly differently.
With an Isa you put in taxed income. It compounds tax-free (no tax on dividends or capital gains) and you withdraw it tax-free. It is taxed, then exempt. With a pension you put in tax-free income. It compounds tax-free, but you pay tax as and when you withdraw the money. It is exempt, then taxed. So the idea of a “pension Isa” is to switch the system so you put in taxed money and take it out tax-free – perhaps with a government top-up along the way.
There are two schools of thought on this. One is convinced that savers must have tax relief upfront, to incentivise them to save. The other points out that people are more than happy to save into Isas with only the promise of future tax exemption, and also notes that upfront exemption isn’t cheap: it costs the Treasury £40bn a year with most of the benefit going to higher-rate taxpayers – a nastily regressive system. So what’s best?
Osborne has launched a consultation, which we hope will recommend a new Isa-style pension – differing only from an ordinary Isa by restricting when the funds can be drawn down (perhaps from 60 or 65). It would be simple (almost no one outside the industry understands pensions, but pretty much everyone understands Isas), which would motivate savers more than upfront tax relief ever has.
Not everyone agrees. The main problem, says David Robbins of Tower Watson in the Financial Times, is that this system could be seriously unstable. Say a new pension Isa were put in place with a 50p per pound top up to savings, up to a limit of, say, £4,000 a year (as suggested by the Centre for Policy Studies). “The top-up would be easy to tweak, an irresistible plaything for future chancellors”.
Given endless regulatory change, who could be confident that on retirement they would really be able to access their cash without paying more tax? We have sympathy with this view. But the current system suffers the same problem, and a lot of that is a direct result of its complexity. If voters don’t really understand something, it’s easy to fiddle with.
If they do understand it, fiddling is harder. That’s why the Isa system has been pretty much unchanged since 1999 and why child trust funds have been changed to Isas. It is also why we think that, if we want people to save sustainably for their futures, a pension Isa could be the way to go.