15 Jul 2015, 11:00am
personal finance:
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  • UK government pensions consultation

    I shouldn’t think there’s anyone reading this who doesn’t read Monevator, but there’s apparently a consultation on about UK pensions. Props to The Accumulator for trying to sift the mutually contradictory desiderata in the comments thread into a narrative suitable for Her Majesty’s Government, who will probably file the results in the round filing cabinet on the floor.

    Nobody actually does a consultation to find anything out, they do it to put a veneer of faux democracy on the decision they are going to take anyway. Most of the motivated commenters are richer though not necessarily wealthier than I am 1, so the issue of the life time average and the annual contribution limits exercise many. I would have been sore about the annual limits as set now but I didn’t have £225,000 handy to put into a pension when I was going for it so I was okay. This isn’t my problem any more, because once I am 55 I won’t have space to avoid paying tax on pensions, so more pension saving isn’t useful to me. In the unlikely event that I decide to become a wage slave/productive member of society again I’ll just have to suck it up and pay tax, as my personal allowance will already be eaten up by existing income. Which is obviously a disincentive to putting my shoulder to the wheel of raising Britain’s dreadful productivity, though I will show later that it appears the Government has already decided I am over the hill in contributing to STEM activities, so it’ll be making knick-knacks on Etsy for me then. Bollocks to that, Iain Duncan-Smith. That’s the joy of financial independence – being able to issue that command.

    I paid less tax in my last three years by using pension saving than probably at any time throughout my working life even though I was in theory a 40% taxpayer. Yes it would be nice if I could save more than £3600 p.a. into a pension now and get back the tax, but so what.

    The straws in the wind are that the Government want to do for the 40% and up tax relief on pensions, perhaps making it about 33% for everyone, because the people they want to incentivise are basic rate taxpayers, higher rate taxpayers are rich enough to sort themselves out. It’s worth observing that a basic rate taxpayer can get 32% tax beneift if you can save into a pension by salary sacrifice, because the contribution comes off your pay before NI and tax are charged. But that’s for some future budget. Let’s just say that I am not yet putting my £3600 into a pension because if I can get 33% rather than 20% relief it will cost me £2400 rather than £2880. It’s not a huge amount of difference but it’s worth waiting till March 2016 for.

    The overall feeling seem to be that the well off and the rich have been making hay on the pensions front and this will get screwed down. In some ways pensions are an odd incentive – the government is encouraging people like me to leave the workforce early, some 8 years (relative to The Firm’s NRA) to 15 years (relative to my State Pension Age), while at the same time hollering that the country is short of scientists and engineers. I am tickled by the casual ageism of the Government’s report on High Level STEM Skills – supply and demand

    However, it is the inflow of new STEM graduates that is more likely to help ensure workers have knowledge of the latest science and technology – retaining older individuals does not do this.

    That’s the trouble with those old dogs – you just can’t teach ’em new tricks 😉 Bless. What they are saying is that we need young scientists and engineers – the Zuckerberg doctrine at work.

    away with ye - dead wood in the white heat of technology

    away with ye – weed out dead wood in the white heat of technology

    I have heard the theory that while the artistic side of CP Snow’s Two Cultures deepens and matures with age Zuckerberg may have a point in technology that young people are just smarter –  it seems echoed at GOV.UK 😉  I also observe that companies can’t be bothered to train young people in their specialisms these days – to wit:

    A representative of one of the major engineering companies noted, “For mechanical engineering, I would agree [there is no shortage]. However, for electrical / electronics, there are simply not enough graduates with the right degree and employers are trying to recruit from a small pool of those with the right degree content (i.e. higher-voltage direct current is a pre-requisite for the transmission and distribution industry: there the supply of graduates is inadequate)”.

    You, Mr Representative, are the problem, because of the fecklessness of your company. When I joined the BBC, with their specialism of colour TV, they damn well trained their graduate entry for a few weeks into the intricacies of the subject at their training facility in Wood Norton. You go to university to learn how to learn, and grasp the high-level aspects of your chosen field. Exactly what part of investing in people does this damn company not understand?

    The upshot seems to be that the Government wants to spend less on pensions tax relief, and in particular less on pensions tax relief for the well-heeled. This was also a theme of the Coalition government before this one. The Tories clearly have the interests of old money at heart with their fondness for inherited wealth and the iniquity that goes with that encouraged in the Summer Budget, but they are perhaps less fond of the nouveaux riche and their tax avoidance through the pension system. Hence the double targeting of the lifetime allowance, aiming to limit tax-advantaged pension income to about £40k (SWR of 4% on a lifetime allowance that seems to be trending towards £1,000,000, currently £1,250,000) and limiting the annual contribution rate to £40,000. The combination seems a bit rough – elementary arithmetic shows a young pup in the finance industry could just about make it, if he gets his running shoes on and saves the full £40k every year from graduating at 21 to becoming a greybeard at 52 (how many 52-year olds are there in finance?) but he better not want to buy a house, he needs to be prepared to eat ramen in those first few years and not inflate his lifestyle. In practice it’s not quite as bad as that, compound interest typically doubles the real value of savings over a 40-year working life, but it’s not going to be easy to reach the lifetime allowance with the annual allowance.

    I don’t understand the double whammy. There’s a case to be made for the lifetime allowance – there’s no need to tax-favour pension incomes of more than twice the median wage, but I don’t really see the point of the annual allowance limitation. And I certainly don’t agree with having both limits in place – one of the other seems okay. People’s careers vary much more than they used to, and the lifetime allowance sets a target of saying ‘this much income can be saved tax-advantaged, no more’. The annual allowance arbitrarily limits the capacity of the feckless Johnny-come-latelys to fix their pension savings in their forties and fifties – not everybody is a Steady Eddie on this.

    Notes:

    1. you are rich by the size of your wad and/or income. You are wealthy by how much of your income is committed/how many years your wad will maintain your lifestyle – open-ended for the financially independent. There is correlation but not necessarily causation between the two, because of the astronomical variation in lifestyle costs

    As a higher rate public sector worker I think the annual allowance is targeting this group in particular, with defined benefit pensions.

    I think the savings are large in this area but I agree that for people saving into a SIPP the 40k limit is counterproductive.

    I also found out the other day that although you can carry over the 40k limit for the last 3 tax years you can’t carry over salary, so if you earn 80k a year but don’t pay in anything for 4 years you can still only pay in 40k in the most recent year.

    Ahh the troubles of being well paid money squirrel.

    Couple of things:
    Not sure I totally understand the retirement pension schemes in the UK but in Canada you can contribute to an RRSP only if you’re working and getting income that way. (OK if you have property rental income you can use some of that.)
    In general, no pensioners need apply. The max you can contribute is 18% of income annually to a maximum of $24K and that is reduced if you have a DB pension scheme. Some lucky folks have no RRSP headroom at all. During my work life I was able to put away maybe $4K each year in addition to my DB pension contribution.
    Our TFSA has a max of $10K per year and anyone can use it but that’s with after tax income.
    The idea that old folks cannot do STEM is risible. I learned Linux when I was past 60. I retired not because I was too old to do science but because I was fed up with sitting in BS meetings with people who were too stupid to understand technology in their 20s and 30s.

    Something you perhaps overlooked — the lifetime allowance has effects that are even more arbitrary than the annual allowance.

    With the annual allowance at least you are in control of how much you contribute. High earning year? Put more in. Low earning year? Put less in and wait, with at least some (albeit limited) carry forwards to future higher earning year.

    But the lifetime allowance applies not just to contributions but rather to the overall balance. This includes any and all investment growth, over an entire working lifetime of maybe four decades. No individual can reliably estimate or forecast that, much less control it.

    Once one is over the lifetime allowance the investment and pension savings conditions are such that it would have been better not to have saved into the pension earlier. But those years cannot be lived again…

    One final note. Your £40k/year from a £1mm pension pot is probably not unrealistic, but it is at odds with what defined benefits folk get. A defined benefits pension is valued at 20x annual payout and is likely inflation linked and with a spouse element, so defined benefits folk (for example, MPs and civil servants) don’t run into lifetime allowance limits until their annual pension exceeds £50k/year.

    By contrast, a defined contributions pension pot at the lifetime limit of £1mm would only buy an annual pension, via annuity with similar conditions, of around £27k/year. For defined contribution savers then, the lifetime allowance has been lowered too far.

    @revalcram – I’ve seen at least one commentator claim the opposite this is harsher for DC pensions than DB, presumably because the 4% SWR implies a 25 times multiplier rather than the 20 used for DB!

    I was sore about not being able to carry over salary in 2009 😉

    @Ray – even an non-earning Ermine can put £3600 a year into a pension at a cost of £2880, which is unlike your RRSP. And I fully intend to carry on doing that until I draw my main pension, because a free £720 a year is worth having. I could carry on after that, but I’d only get 25% tax-free, and I can’t be bothered for £180.

    Your equivalent of our annual allowance is about a quarter of ours, which looks tough if that’s the only pension savings.

    @Mumble agreed, the LTA makes it hard to manage. A rational optimiser would hit it hard early on, then scale back their savings rate as they get older. This sits ill with the typical career arc and indeed the typical human lifecycle with the expensive costs of housing and children in the 30s to 40+ mark.

    I was comparing a drawdown scenario. It;s tough to make meaningful comparisons with annuities at the moment, they would make the pension unusually low compared ot historic levels.

    @ermine we have the state sponsored Canada Pension Plan and Old Age Security which for current pensioners maxes out at approx $12K and 7K per annum respectively. Any DC DB or RRSP pension income would be on top of that up to $72K after which the OAS is clawed back in part.
    Typical income from the state dole is about $15K. Seems to me if that is all you have there’s a lot of cat food in your future.
    Our maximum allowable RRSP contribution of 24K might seem niggardly to you but only about 13% of Canadians are maxing it out every year.

    16 Jul 2015, 9:45am
    by Neverland

    reply

    George wants to cut pension tax relief to pay for abolishing the 45% additional band and raising the 40% band to £50k in 2018 as some red meat to the tory faithful in advance of his bid to be re-elected prime minister

    There isn’t really anywhere else in the tax system you can get c. £20bn required

    But maybe im just a cynic

    I know in the long term we are all dead, but isn’t one aspect of the mooted change to make pensions tax free on the way out (as Australia does, incidentally) that with an ageing population the state relies even more on the decreasing percentage of the population who work.

    The idea of income tax being paid only by <50% of the population worries me. The increase of our personal income tax threshold is already unhelpful enough; if we end up (in 30 years' time) with no pensioners, no part-time workers etc paying income tax then either income taxes need to be sky high, spending taxes need to much higher than now, public spending needs to be rock bottom, or the government goes bust.

    This is not Osborne's problem but somebody should be calling him out on the long term pitfalls.

    @Ray the state sponsored pensions (if they add) are a teeny bit more generous, but the restrictions on RRSP make it tough to top that up much, unless there are other ways. For instance saving in tax-paid but then sheltered systems in parallel would work, in the same way I use an ISA in parallel.

    @Neverland that’s perhaps not unreasonable as a way to shift the bulk of pension benefits down the pecking order a little…

    @FIREvLondon – perhaps Osborne is looking ahead to when automation means JMK’s Economic Possibilities for our Grandchildren comes to pass 🙂

    If we look at the big picture careers peak faster nowadays, and the concept of retiring early/FI is a thing. That just wasn’t the case at all when I started work in the early 1980s – blue collar workers worked to 65 and white collar workers worked to 60, end of. Of course some people were of independent means, and some of the few individuals who were business owners and who were successful would racily retire in their 50s. And we’d always had the aristocracy.

    JMK thought solving the economic problem would mean we work less but for the same working life – people really, honestly, thought we would be working a 10, 20 hour work week, but still for 35-40 years

    Companies hate managinmg lots of part-timers, so what seems to be happening is more people work a shorter working life, and unemployment rises from the unskilled end as we have fewer and fewer unskilled jobs, though the way things are going most people will be unskilled.

    And yet if automation and business can continue to produce the same amount with fewer and fewer people the problem will metamorphose – because fewer and fewer owners will produce the same amount of goods and services, but struggle to find buyers.

    The increasing polarity of income, and indeed the fact that pretty much only HRT payers and above make a net contribution to the government coffers are straws in the wind, here. A modern postindustrial economy can’t use the work of an increasing number of the humans it ‘serves’, although it still seems to be able to produce the same GDP without their work…

    @ermine the TFSA (your ISA) is a relatively new plan here. Between the two you would be able to save $34K per year of which $24 K is tax deferred. Employers may have some sort of matching or defined contribution plan, or if you’re really lucky a defined benefit plan. The two government plans are additive.
    I never had the TFSA during my working life so my pension income is partly defined benefit and partly from the two government plans. I also have some RRSP money which I can take as needed but I have to start a withdrawal plan at age 71. In Canada this plan is called a RRIF (Registered Retirement Income Fund.) Or I could use the RRSP funds to purchase an annuity but since I already have a fair amount of regular pension income I probably will not.
    Average Canadian income is approx $50K so an annual savings limit of 34K is in my view pretty generous. Besides there is no reason why you can’t save more in non-registered plans. Both capital gains and dividends receive quite advantageous tax treatment here so your tax bill on a non-registered account could be fairly low,

    @Ray average UK earnings (and I fear this is household!) is 27k. However, the 40k strikes me as about right though I favour dropping it for the overall limit. Why? Because the ability to save for a pension varies hugely through the life cycle and across different sorts of careers. I saved nearly half as much in the last three years of my working life as the capital base my DB pension stands on which was accrued over nearly a quarter of a century.

    I must hat tip the 2009 global financial crisis for a fair amount of leg-up, but nevertheless I contributed about two times gross salary in those three years. I would have struggled to do that under the current regime. The opportunities have a hell of a peak to mean ratio, but it’s the total amount saved over the working life that delivers the goods. For some people that will be all in a rush at the end, for some it will be a slow and steady trickle. And that’s OK – the LTA defines roughly the total amount of pension that will be tax advantaged, there’s no need to fiddle with the way it happens.

    @ermine,

    Re “the LTA defines roughly the total amount of pension that will be tax advantaged”, this is still a bit off, since (again) it covers growth as well as pension contributions. Changes to the annual allowance are purely prospective, but changes to the lifetime allowance are both prospective and retrospective.

    In my case the continual lowering of the lifetime allowance is actually a motivator to leave work early. With my pension savings now bubbling just a smidgen below the lowered lifetime allowance of £1mm — thanks, as you say, to a leg-up from 2009’s rebound — but with no need to draw them for five years or so, I will have to apply for fixed protection. Under fixed protection I will no longer be able to contribute to any pension scheme. This means I forego my company’s contributions. This equates to an approx 10% drop in salary. Maybe more if we factor in the lost tax deferral.

    Because I am 55 work for me has become somewhat optional, and the retirement planning problems and distortions I have to endure from the ever-reducing lifetime allowance may well tip the balance. I had considered working three or four years longer, but now probably will not due to the effective and noticeable drop in salary. A net lifestyle improvement for me then, but a net loss to the my employer and to the exchequer. Meh. The latter in particular is not my worry.

    @FIREvLondon,

    On “the idea of income tax being paid only by <50% of the population worries me," according to The Times, quoting the Office for National Statistics, we're already there:

    http://www.thetimes.co.uk/tto/news/uk/article4483534.ece
    "51% take more in benefits than they pay in taxes"

    @Mumble, I accept it’s late and after some wine, but, erm, I’m not sure I see the problem. The ghost of JMK is speaking across the years –

    In my case the continual lowering of the lifetime allowance is actually a motivator to leave work early. With my pension savings now bubbling just a smidgen below the lowered lifetime allowance of £1mm — thanks, as you say, to a leg-up from 2009’s rebound — but with no need to draw them for five years or so, I will have to apply for fixed protection. Under fixed protection I will no longer be able to contribute to any pension scheme. This means I forego my company’s contributions. This equates to an approx 10% drop in salary. Maybe more if we factor in the lost tax deferral.

    Because I am 55 work for me has become somewhat optional, and the retirement planning problems and distortions I have to endure from the ever-reducing lifetime allowance may well tip the balance.

    I don’t see the problem 😉 I’m a shade younger than you and they ain’t making any more time for you either. We have a feedback system that is delivering an unequivocal message. You know what you have to do.

    We should be grateful that we are living in times where the accumulated wisdom, experience and talent of Man has made this possible, IMO…

    @ermine,

    Well, it’s not really a problem for me. I like my employer, enjoy my job, and would happily carry on for a few years in exchange for fattening up my pension to increase the range of things I can do once I retire. Perhaps that makes me an anomaly, but hey-ho, it’s certainly not dreadful if I go sooner instead. So I shall, and I will enjoy it when I do.

    It is however a problem for my employer, and for the exchequer who will lose out from all that tax and NI I would have paid — the same set of perverse incentives that you note above with your comment about how you’d face full tax if you returned to employment, thanks to other income consuming your annual tax allowance.

    Also, I’d have liked the *choice* about when to retire, rather than have it pushed on me. But then, many people are urged into earlier retirement than planned for a variety of other reason — employer downsizing, ill health, dreadful employer, and so on — so I guess I’m simply getting a taste of what they all feel. It’s odd to be pushed out of a job by a government policy that is supposed to *increase* government revenue, but there you have it. I doubt that I will be the only person in the country affected in this way. Perhaps it will become harder and harder over the years to find an experienced lawyer, doctor, or dentist because they have all decided to retire early for the same reasons I have. Unintended consequences and what have you.

    Anyway, thanks for engaging on this. Longer discussion than intended; I really only wanted to note that your view of the lifetime allowance as not distortive isn’t the full story.

    17 Jul 2015, 8:44am
    by Neverland

    reply

    @Mumble

    Why won’t your employer just hire or promote someone to do your job and then hire to backfill?

    Most people aren’t so unique someone else can’t do their job

    My point is the exchequer loses nothing

    @Mumble – but you do have a choice, and indeed agency, unless your boss is actually offering you the P45 which doesn’t seem to be the case. To some extent you’d take an effective pay cut to continue working, given the opportunity cost of pension savings. Agreed that the LTA has some distorting effects, but nowhere near as much as the arbitrary £40k limit given the variability of careers nowadays.

    £50k is a lot more than the vast majority of people earn while working – with that pension income you are in the 90th percentile of UK earnings – even a 40k gross pensioner is in the 85th income percentile.

    It’s difficult to see why you’d need more encouragement to save – indeed there’s an argument to be made you need to be encouraged to retire soon and spend some of that money and get it into circulation hiring bar staff, hoteliers and makers of goods and services for the upper 10% of the income profile rather than accumulating more 😉 Share the love around and improve the velocity of money! Plus some young fellow who desperately wants to enter the sausage-machine will get a break, which will enhance their quality of life and save a little bit of unemployment benefit and a lot of mental anguish.

    A shorter working life is one of the knock-on effects of increased non-human productivity IMO. I understand how you feel – all through my working life I had expected to work to 60 and then retire, and making the wrench early was not a pleasant experience, because, well, unexpected change is tough to digest at first.

    But once you have made the jump and look back, the case for early retirement improves as you discover the joy to be had in time, and spending it with people you love and doing what you like. In retrospect I should have left earlier – not only would I not have run into some nutty HR practices, but I would have used more of my limited time on earth to my own ends. However, it did take me at least two years to realise that! Here’s to you feeling the same if you do go, and if you don’t, well, that’s also a good option – congratulations on getting into a dilemma – of two excellent but different ways forward 😉

    @Neverland: “Why won’t your employer just hire or promote someone to do your job and then hire to backfill?… My point is the exchequer loses nothing”.

    My employer is multi-national. My job will be done by someone else who is not in the UK.

    I’ll admit that all of this makes me perhaps an edge case, but overall the constant clampdown and erosion, via the LTA, on pensions for upper and middle earners is going to produce skills shortages in areas where skills take a long time to develop. I’ve cited doctors and dentists, but there will be others.

    @ermine,

    I get your point entirely (although you keep on citing £40k/year whereas a better figure would be an annuity rate on £1mm, which is much less at £27k/year). I saved hard for a pension early in my career so that I would have the *option* to retire early if I wanted to. As it turns out, later in my career I’m rather disappointed to find that I have less “option”, not in the sense that I *cannot* retire early but rather that I am *incentivised* to retire early by the fact that I saved hard. Had I not done so, I could instead be saving now (and, I’d note, at a much better tax deferral rate than on my early career earnings).

    Anyway, you’re right that some of this is about the wrench of going *at all* rather than financial sub-optimization. But it has to be faced, if not now then later. I shall enjoy my early retirement, and look forward to increasing the velocity of money. As it turns out, much of that velocity may happen in other countries since I intend to travel widely and for long periods, but it will be velocity nonetheless. I’ve already started planning.

    17 Jul 2015, 1:33pm
    by Neverland

    reply

    @mumble

    Quitting work because the LTA means you have to take a 10% pay cut because your employer won’t compensate you if you don’t want them to make any pension contributions is a bit of a #firstworldproblem

    You seem to be griping because the government won’t be giving you a further tax defferal break on a pension fund that is already bigger than more than that 95% of UK workers

    I just don’t see why other tax payers (because there isn’t anyone else to fund it) should have to pay for that for you

    You are coming across as a petulant adolescent

    @Neverland

    Nobody but me is *funding* my pension. Deferral is not relief.

    I have paid a lot over the years for other people’s child tax credit and what have you, and haven’t complained about that, yet I don’t have children. So I could ask why I have had to fund that. But I don’t. It’s part of the package. But so should be safe and predictable retirement saving, yet it is not.

    You are coming across as a sneering bully.

    https://www.psychologytoday.com/blog/beyond-heroes-and-villains/201408/stop-picking-people-their-first-world-problems

    It’s good to play the ball not the man, guys 😉

    It’s a fair point that the tax break is not taking away from income earned rather than a subsidy. Though it’s also a fair point to query at what point perhaps the opportunity cost of tax foregone should be targeted at the lower-paid.

    I’ve been on both sides of that – once with an intemperate post on the Laffer curve and t’other side in favour of a universal income

    let’s keep it clean…

    @ermine forgot to mention that you can carry forward any unused contribution room to your RRSP in Canada – so if you did not contribute the max for 10 years you could make up for it later in life. I don’t know if your contribution room can be carried forward in the UK or whether you must use it or lose it in a given tax year.

    @Ray – that makes the CA version a lot better re varying career income. We can carry forward three years of annual allowance. If I am a steady earner of say £20k p.a. that doesn’t help. If I contributed nothing for two years and then want to catch up, athough I have in theory £60k annual allowance I’m then limited by the total amout I earned. However if I have a highly variable income of 20k, 20k, 20k, 100k I beilieve I could save the entire 100k (3*20k + 40k annual allowance)

    The CA method sounds like the more civilised lifetime allowance don’t care how you get there that I was advocating – drop the annual allowance.

    Varying career income is going to be something we see more of IMO.

    @ermine here’s how the RRSP contribution limit works in Canada. If you make say 80K per year your limit is 18% of that or approx. 14.4K. However if you have a DB pension the tax folks work out something called a Past Service Pension Adjustment (PSPA) and that is deducted from what you can contribute in any tax year. This PSPA could amount to 10K so in the final analysis the max you can contribute to your RRSP is 4.4K. The idea is to be fair to those who don’t have a work pension by giving them more opportunity to save tax deferred.
    However you do have that DB pension to count on. And your DB contributions are tax deferred.
    If you have no pension plan then the whole 14.4 K is available. And if you don’t contribute it is added to your headroom and carried forward indefinitely.
    There is no lifetime allowance but when you come to take out cash from your RRSP you’ll pay taxes at your marginal rate. Hopefully that will be less than when you were working.
    You also have 10K headroom in a TFSA but that is in after tax money.

     

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