The recent proposed changes to pensions legislation have surely been the most radical since the advent of the section 226 contract in 1970. The relative merits of these changes have been discussed at length elsewhere (and should continue to be discussed at length as the ramifications for the economy and future generations are so great).
I have a different question, however. Have the willingness of politicians to so fundamentally change the rules on pensions rendered them useless as a financial planning tool?
What are the features of pensions that can be changed? This list is not be exhaustive, but they include:
Tax relief on contributions
Tax position on growth of fund
Tax position on death before retirement
Tax position on death after retirement
Maximum size of fund
Maximum annual input allowed
Tax free amount on taking benefits
Age at which benefits can be taken
Maximum levels of income
Tax on income
How income can be taken
Any of these can (and most of them have) been changed by politicians. This means someone who has built up a pension fund does not know what rules will affect them in the future.
But pensions have one overriding feature that marks them different from any other type of investment. Unlike, say, ISAs, you cannot disinvest from a pension. Other than taking benefits, once the money is in, it cannot come out again.
This means that when politicians change the rules, it is a form of retrospective taxation. When Gordon Brown scrapped tax relief on dividends in 1997, people with existing pensions couldn’t decide to cash in before the new rules came into force. They were stuck.
The proposed changes could encourage someone to put much more money into pensions than before on the basis that
a) they could create a fund free of inheritance tax (at least before 75), and/or
b) they can take the whole fund out over period of time at basic rate tax
Suppose this new freedom turns out to be a bad idea, and Government realise that lots of people are raiding their pension funds and more are likely to become dependant on the welfare state. This isn’t a prediction (well….) but let’s just imagine.
A future Government therefore brings back the cap on the annual income. Those clients who built up large funds with plans to, say, reduce debt by taking out large sums would, to use the vernacular, be knackered.
Now, I’m not asking you to agree whether this is likely. Only that it is possible. And if it is possible, then doesn’t that mean we cannot use pensions as a basis for planning for the future?
It’s arguable whether these changes are politically motivated (all I’ll say is why would a Government give away £150m on a tax reduction no-one was calling for 6 months before a General Election while councils have to sell playing fields in a desperate attempt to raise money). But they ARE decisions made by politicians following political ideology (freedom of choice, for example).
We’ve always told our clients that pensions should provide a subsistence level of income, and that other vehicles should also be used. I’m sure this is the approach of most firms, and the new rules won’t change things. But not everyone asks for advice.
So, my question for you: Are pensions now unusable as a basis for long term financial planning?