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Pension changes could cost 11m Britons thousands of pounds

Companies could slash pension promises to 11 million employees, potentially knocking thousands of pounds off the incomes of people in retirement, if proposals in a government consultation paper are approved.

Unions are likely to react furiously to the proposals, which would allow companies to save £90bn by providing annual increases in their retired employees’ pensions based on the consumer price index, rather than the retail price index.

As CPI is generally lower than RPI, the impact on pensioners is likely to be significant over time. Analysis by advisers Hargreaves Lansdown suggests that for every £1,000 in pension income in 1988, under RPI it had increased to £2,586 this year, but only £2,105 under CPI.

The changes are flagged a green paper issued by the pensions minister, Richard Harrington. It cites estimates from pensions consultancy Hymans Robertson that a shift to CPI would “take away about £20,000 in benefits over an average DB (defined benefit) scheme member’s life”.

Currently, 75% of pension schemes in Britain increase payouts to members each year using RPI rather than CPI, and usually the scheme rules and legislation prevent companies from lowering their promises.

But the paper asks: “Should the government consider a statutory override to allow schemes to move to a different index, provided that protection against inflation is maintained?”

In some circumstances, where a company is facing significant financial challenges, it could suspend pension increases altogether, the paper adds.

“Allowing all schemes to move from RPI to CPI would have [a] significant impact on members’ benefits. CPI has been lower than RPI in 22 years out of the last 27 (and nine years out of the past 10) up to 2015, and so [it] would in all likelihood represent a reduction in members’ benefits,” the paper acknowledges.

The change would affect 11 million people in defined benefit schemes, also known as final salary schemes, where the level of pension in retirement is a proportion of the person’s salary. Most private companies have closed these schemes, replacing them with pensions where the payout is entirely dependent on the performance of stock and bond markets.

Harrington said: “We all have a responsibility to ensure the system works in the interests of everyone – employers, schemes and scheme members. This green paper sets out the evidence we have available about the key challenges facing DB pension schemes and highlights a number of options that have been suggested to us to improve confidence in the system.”

But the former pensions minister Steve Webb, the director of policy at pensions company Royal London, said: “The most worrying proposal is to allow certain schemes to ‘suspend’ annual pension increases if money is tight. With rising inflation, annual indexation is an important part of protecting the living standards of the retired population.

“There is a significant risk that relaxing standards on inflation protection with the best of intentions for exceptional cases could be exploited and lead to millions of retired people being at risk of cuts in their real living standards.”

Tim Sharp, a pensions expert at the TUC, said: “Pension reforms should be judged on whether they improve workers’ standard of living in retirement. It is hard to see how measures that transfer wealth from pension savers to shareholders would achieve this.

“We shouldn’t cut members out of decisions to water down pensions, which are, of course, deferred pay.”

The paper makes it clear that the shift from RPI to CPI is only under discussion and, in a surprise rebuke to the pensions industry, says Britain’s final salary schemes are more affordable than widely believed.

It notes that deficits in pension schemes have narrowed from a peak of £400bn to £196bn and “the evidence that DB schemes are unaffordable is far from being conclusive and should be considered with caution”.

Companies that complain they cannot afford their pension schemes seem to be able to pay out large dividends to shareholders, the paper notes. “In 2015, FTSE 100 companies paid about five times as much in dividends as they did in contributions to their DB pension schemes,” it says.

“The 56 FTSE 100 companies with a DB pension scheme deficit paid 25% more in dividends (£53bn) relative to their deficit (£42bn). Therefore, in theory, these companies have the ability to immediately repair their pension scheme deficits were they to feed their dividends into deficit repair contributions (DRCs).”

Government urged to scrap ‘unfair’ tax raid on older pension savers

Older savers who return to work after dipping into their pensions will see their ability to save hampered by an “unfair” tax raid which the Government is facing pressure to scrap.

From April the Treasury is planning to reduce savings limits for over 55s who have already used the pension freedoms to access their money from £10,000 a year to £4,000.

The change will put workers earning more than £40,000 a year at risk of receiving shock tax bills if they spend as little as £1 their pension and then continue to save 10pc of their salary, calculations show.

Last night experts urged Phillip Hammond to abandon the move which, they warned, would fly in the face of a separate Government push for working age people to care for elderly relatives.

Last month David Mowat, care minister, said Britain’s ageing population meant parents needed to be as responsible for the care of their elderly mothers and fathers as their own children.

Tom McPhail, head of pensions policy at Britain’s largest pension firm, Hargreaves Lansdown, said: “This will come as a nasty shock to people hoping to take a career break or cut down hours to care for a elderly relative. If they use pension savings to support themselves, they face being heavily penalised.

“The Government that has lost sight of the importance of putting individuals first. This will inconvenience and disproportionately penalises millions of ordinary savers and its barely going to save the government any money. It must be scrapped.”

Tom Selby, senior analyst at AJ Bell, another pension firm, said: “Given that most people won’t be aware of these plans there is a significant risk large numbers will accidentally overpay into a pension and be hit with an unexpected tax charge.

“The Government needs to accept the current rules are not fit for purpose. It should shelve this unfair cut in pension savings incentives and go back to the drawing board.”

Last year the Treasury announced plans to scale back the amount people drawing from their pension are allowed to continue saving over fears that many would abuse the system by claiming tax on it twice.

This tax trick, commonly referred to as “recycling”, is a loophole which was created by the pension freedoms, which were introduced in 2015.

HMRC data reveals that since the new flexibilities were introduced over half a million savers have used the pension freedoms, with millions more expected to do so over the coming years.

Under current plans people who have already used the pension freedoms will be able to save up to £4,000 a year and still claim tax relief at their marginal rate. Savings above the limit will not receive tax relief.

The Treasury is currently consulting on the finer details of how the policy will work with the deadline for feedback on February 15.

In the consultation document the Treasury said: “We believe that an allowance of £4,000 is fair and reasonable and should allow people who need to access their pension savings to rebuild them if they subsequently have opportunity to do so.

“Importantly, however, it limits the extent to which pension savings can be recycled to take advantage of tax relief, which is not within the spirit of the pension tax system. The government does not consider that earners aged 55+ should be able to enjoy double pension tax relief i.e. relief on recycled pension savings.”

The best way to make pensions sustainable is to reduce the tax burden on saving

The Government consultation paper published yesterday on “defined benefit” (DB) pensions does its best to sound reassuring and even positive. There is no crisis in such final salary schemes, it soothes, suggesting that most companies can easily afford to meet the mounting costs of paying those pensions. Yet these assurances are undermined by the facts: many companies have closed their final salary schemes to new entrants, meaning that, in the words of the Office for National Statistics, “for the younger generation, the option of joining a DB scheme is much reduced”.

Now those who were fortunate enough to enrol in such schemes could see cuts in the value of pension payments they had thought were guaranteed. It may be the case that, in some circumstances, it makes sense to allow an employer to reduce pension payments below the rate of inflation, to ease the pressure on a company’s finances. But such measures should be an absolute last resort and must be policed tightly to ensure they are not abused.

More importantly, any such changes to final salary rules cannot be done in isolation. What is needed is a wider overhaul of the rules on pension saving, to encourage and reward that saving. The best way for the Government to do that is reduce the burden of tax it puts on pensions. Lifetime and annual caps on pension saving unfairly penalise the most thrifty and thus deter savings. Pension funds themselves are also burdened: Gordon Brown’s infamous decision to tax the dividends they receive from shares still costs them tens of billions of pounds a year, money that would otherwise go to pensioners. Today’s Conservative Government should give thought to easing those burdens.

A proper debate about ending the Bank of England’s quantitative easing programme – which hurts pension funds’ bond investments – is also long overdue.

And to be politically sustainable, any changes in the rules for private sector pension schemes must be accompanied by greater reform in the public sector. The gap in pension provision between private and public employees is now intolerably wide: talk of a “pensions apartheid” is growing. A situation where some workers retire in comfort, while others with comparable (or even greater) talent, experience and effort struggle, would be socially divisive and deeply unfair. If tough choices are needed on pensions, public sector workers must take their fair share of the pain.