The regulatory impact of simplifying the pension system
One of the many documents published by the Government following last week’s Finance Bill was a Regulatory Impact Assessment (RIA), signed by the Financial Secretary to the Treasury that effectively says that the Treasury is satisfied that the benefits of pension simplification will justify the costs. What follows here is my own short and patchy summary of that 20-page document along with the odd comment of my own on some of the issues.
To kick off with, the RIA says that, once the dust has settled on all the tax changes, we will only have 151 pages of primary pension legislation along with around 100 pages of secondary legislation and something like 350 pages of detailed guidance. This might seem a lot (and come well outside of most peoples’ concept of ‘simple’), but it compares favourably to the current 350 pages of primary and secondary legislation and close on 1,000 pages of detailed guidance.
The way this has been achieved has been mainly by getting shot of the existing six existing tax approved regimes and tidying up the current two regimes for unapproved schemes. These are the fabled ‘eight pension regimes’ journalists keep going on about, but hardly anyone you ever meet can ever name. For the record, the eight regimes are as follows:
- The so-called ‘Old Code’ schemes. These are kind of dinosaur territory for people who’ve been cosily tucked away in pension schemes since 1970. The schemes haven’t been able to take in any new money since 1980, but some are still hanging on in there with their tax-approved status, and benefits can still be paid out of them.
- The ‘pre-1987 regime’. The gold standard of pension arrangements in my opinion, and if we were only going to have one regime this would have got my vote, but it’s a bit on the generous side for the Government’s liking I’m afraid. Once upon a time (when we actually had a single regime for occupational pension schemes) it was the one regime available (apart from the ‘Old Code’ stuff) for all of us, but has since been restricted to just those of us who commenced saving for our current pensions between 1970 and 1987, when it was knocked on the head.
- The ‘1987 regime’. This was the tax regime mainly designed to limit tax-free cash for high earners by introducing an unindexed cap of £150,000. It did introduce a few other bits and pieces, but it was really all about limiting big cash payments to fat cats.
- The ‘1989 regime’. Two years after limiting the tax-free cash the Government came up with the better idea of limiting the pension benefits as well (you know, like why just leave it at the tax-free cash, sort of thing) and came up with the idea of the ‘Earnings Cap’, putting a maximum salary that could count towards pensions and tax-free cash in the way of high earners. All of this, of course, was done to affect future job changers and new entrants to the pension markets only. Everyone who had pensions in place before 1989 and just kept their heads down and stayed put, got left alone and could keep the old (more generous) rules. That’s why this new stuff going through in 2006 is different to what we’ve seen before. It’s retrospective and flushes out all the die-hards who’ve kept hold of the benefits of the old regimes. Some transitional arrangements have been put in, mainly I think because so many people made a big fuss about it all during the consultation period, but these are far from simple and look pretty advice-intensive to me.
- Retirement Annuity Contracts (RACs) also constitute a separate tax regime. These too are from the dark ages of pensions, having been introduced in 1956 and broadly left alone until they were killed off when Personal Pensions came along in 1988. Not so much killed off though, rather just winded a bit. You know, nasty bruising, that sort of thing, but still able to stand up and stagger away to a quiet corner having got over the shock of waking up with a crowd around them in 1988. Anyone with a RAC has been able to keep them going ever since, carrying on paying into them and increasing their contributions if that’s what they’ve wanted to do and keeping all the old rules (especially the sometimes generous tax-free cash rules). They even managed to keep the so-called ‘carry-forward and carry-back’ rules that are deemed too difficult for people with Personal Pensions to understand.
- The sixth main regime is the one for Personal Pensions. These came in in 1988 and I’m sure everyone knows the story about that without me having to go through it all here for the umpteenth time. The earlier Personal Pensions (those taken out in the first year they were available) were much better than those allowed after changes that snuck in with the 1989 regime, but for some reason I seem to be the only person who thinks that constituted a separate (and seventh) regime, so I’ll just shut up about it. This RIA doesn’t acknowledge post-1989 Personal Pensions as a separate regime, so I must be wrong. I mean, if the opposite were true I’d know more about this stuff than the Treasury types, and that can’t possibly be right.
- Funded Unapproved Retirement Benefit Schemes (FURBS) popped out of the 1989 introduction of the Earnings Cap. Basically they gave employers the ability to fund benefits outside of the tax-approved regime for capped employees.
- Unfunded Unapproved Retirement Benefit Schemes (UURBS) – keep awake at the back please – are, as the name suggests, sort of unfunded FURBS. It is these two unapproved regimes that the 2006 changes are looking to ‘rationalise’, or in my language, tidy up a bit.
So that’s the eight regimes in a nutshell, and the Treasury reckons that replacing them all in one go in 2006, leaving only a (still unquantified) handful of stragglers with complicated transitional arrangements, will result in overall cost savings in the future of something in the order of £80 million a year.
Apart from the cost savings, the whole idea of this retrospective spring-clean is to get barriers to pension saving out of the way and encourage more of today’s workers to save up for a pension before they become tomorrow’s pensioners. The Government’s judgement on this is that the complexity of the current rules acts against the spread of pensions (something I agree with completely) and that what they’re doing here will help (again, something I agree with). What they don’t even acknowledge, though, and what everybody else who knows anything about the subject thinks is far more important than simplifying the tax rules, is that something needs to be done about the suitability of pensions for everybody in the workforce. What’s needed is a guarantee that every pound saved in a pension will make savers at least one pound better off than non-savers. There’s nothing here about that, nor in the draft Pensions Bill we saw the other month.
Nevertheless, the Government still regard what is going down here as ‘pension reform’ and mention all the many benefits that will come out of the changes. One of these is the fact that for most ordinary pension savers the limits on what they can save for a pension have effectively been removed. The thinnest of the thin cats will be allowed to save just as much as the fattest of the fat cats – we’re all subject to the same Lifetime Limit. This is true and all sounds pretty egalitarian and all, but the real life limits that apply to thin cats have more to do with how much they’ve got left to save at the end of each month than with any arbitrary limits set by pension legislation. We’ve never come anywhere near taking the Government up on the full pension tax-reliefs we’ve had available to us since 1956, and I’m sure if we ever had done they would have been taken away from us by now anyway. Still, on the face of it this new approach treats everybody the same pension-wise.
The same will be the case for tax-free cash sums available on retirement (although I’m not sure what ‘retirement’ means any more as we will all gain the right to draw our pensions while remaining at work, but more of that in later BeeLines I think). After A-Day, everybody saving for a pension will be entitled to a 25% tax-free cash sum when they draw their retirement benefits and the Government’s view is that for most people this will result in an increase in tax-free cash. I agree with this, it certainly will for those currently restricted by the £150,000 1987 rule, or caught by the 1989 Earnings Cap. I’m a bit confused by the 25% as far as ‘simplification’ is concerned though. I can see how it works with a money-purchase scheme – you’ll get a quarter of the fund as tax-free cash. But how does it work with final-salary schemes? I mean, 25% of what? It seems to me that what we currently think of as ‘Revenue maxima’ for benefits need a big rethink. When I’ve thought about that a bit more, I’ll put my thoughts down in a BeeLine.
The Government points out that just doing nothing was one option open to it. Eventually, as those inhabiting the past regimes were to gradually drift into retirement, we would have been left with a single pension tax regime, the post-1989 one. They figure this would have taken thirty years or so to come about, but they felt it was better to act now to immediately realise the benefits of removing the barriers to saving imposed by the multiplicity of regimes.
Pension schemes will also no longer need to seek approval from the Inland Revenue, but will be able to operate on the simpler basis of ‘registration’. All existing formally approved schemes will be able to switch automatically to become registered schemes from A-Day (6th April 2006) unless they want to become ‘unregistered schemes’. Unregistered schemes won’t be called unregistered schemes, though, they’ll be called ‘employer-financed retirement benefit schemes’, or EFRBSs for short. Currently, in the pension argot we use, these are called FURBS and UURBS, so that’s just another bit of the developing language we’ve all got to get our heads round really. The early-adopters have already started using these terms, of course, as a way of making the rest of us painfully aware that we’re about nine yards off the pace. (In fact the whole language thing looks all over the place right through the whole of the Finance Bill, with big changes to terms that have only been with us for five minutes or so – something I’ll be returning to in future BeeLines, if I can be bothered.)
The RIA goes on a fair bit about the fears expressed by some people regarding the widening out of investment options for small pension schemes and individual pensions, particularly the inclusion of residential property. What this is all about is the relaxation for what we currently call Small Self-Administered Schemes (SSASs) and Self-Invested Personal Pensions (SIPPs) of rules restricting the investments they are allowed to make. The single set of rules for all types of pension schemes will mean that SSASs and SIPPs will be able to invest directly in residential property or works of art, for example, things previously prohibited for small schemes. The Treasury’s judgement on this is that there are currently only 200,000 people in SSASs and SIPPs and that represents just 1.3% of all the people in pension schemes, so they don’t think the stories of massive distortions in investment practices are credible. They also point out that 75% of those currently purchasing pensions have less than £40,000 to spend on their annuity. So, these facts taken together seem to indicate that the flow of money into residential property from pensions will be limited.
I’m not too sure I agree with that. As far as I can see, everyone with a Personal Pension will effectively have a SIPP after 2006. I think that’s what ‘one regime’ means. In addition, anyone transferring from an occupational scheme to a Personal Pension will have one too. Not just that, but people without Personal Pensions now will be free to start one under the full concurrency rules coming in on A-Day even if they’re already in another pension scheme, and higher-rate taxpayers doing so would only need a net contribution of £120,000 to purchase a £200,000 holiday let for example. I’m not saying everyone will go gangbusters on this like I’ve heard others say, but I’ve met plenty of people who are beginning to get pretty interested in pensions again, that’s all.
14 April 2004
This document is based on Scottish Life’s understanding of the Finance Bill 2004 published on 8 April 2004. This is draft legislation and may be subject to change.