A unified pension system with Isa features for younger savers should replace the current structure of pensions competing alongside the soon to be launched Lifetime Isa, says Aon.
The consultancy warns that competition between the Lifetime Isa and pensions will grow as auto-enrolment contributions increase to their full level, presenting workers with a complex and confusing savings environment.
Instead Aon wants to see a unified system based around pensions but with early access for younger savers to their own contributions, forfeiting any Government match.
Aon argues that while there is little evidence of competition for AE pension contributions at present, this can be expected to get worse over time as the AE minimum contribution rates are ramped up, and pension savings become more noticeable and demanding for lower paid and younger workers.
Savers will find it harder to understand which products are meant for which sorts of saving – such as house purchase or retirement income – because the Lisa offers both, while pension only offers one, says Aon. The consultancy adds that savers will be confused by two very different vehicles, both of which can deliver lump sums at 60, and neither option addresses the key problem of long-term care.
In its response to HMRC’s technical consultation governing the introduction of Lifetime Individual Savings Accounts, Aon has proposed that AE pension contributions should be given priority, but that explicit recognition of the different needs and financial priorities of younger workers should be incorporated into the system. It also calls for direct recognition of the growing problem of later life social care funding.
Former pensions minister Baroness Altmann is critical of the increased role of Isas in retirement savings, arguing that it will lead to less assets saved when people actually come to retire.
Investment platform Nucleus has also recommended that all self-employed people be able to open a Lifetime Isa up to age 50, and that all communications should make it clear Lifetime Isa is neither a direct substitute for a pension nor has the full flexibility of an Isa.
Aon Hewitt senior partner Kevin Wesbroom says: “Lisa and AE pensions will soon compete. We would prefer to see a uniform system centred around pensions, but with an explicit opportunity for younger workers to be able to access their pensions savings for other priorities, such as house purchase. Pension taxation should move to an explicit uniform incentive, similar to the ‘bonus’ proposed for the Lisa. We have long argued that simplicity and understanding are critical to encourage individuals to save for retirement and that incentives are better for individuals to follow. A bonus is a better motivation than tax relief. A simple transparent system will also keep policymakers honest.
“The Aon model features three components – a Foundation Phase for younger savers, a Pension Growth Phase and a Distribution Phase when members start thinking of how to use their pension pot, using the 2014 Pensions Freedoms. Crucially, the Distribution Phase would give additional incentives where funds are applied to provide for long-term care – an issue which is being ducked by all policy makers, yet is a financial demographic inevitability in the UK.”
Aon Employee Benefits DC proposition leader Debbie Falvey says: “During the Foundation Phase, younger members would be entitled to withdraw their personal contributions, but not the employer’s, from the pension scheme should they require to do so, repaying the linked Treasury bonus. We recognise the challenges in encouraging younger workers to save for retirement as the financial pressures of repaying student loans, purchasing property and other major life events tend to take financial precedence. By building on auto-enrolment mechanisms, but offering a window during which young people need not fear their personal savings are locked up for years ahead, we believe we can reduce opt outs from AE and encourage young members to build up pensions savings from an early age.
“In the Distribution Phase of our proposals, we aim to encourage people to consider leaving their savings invested for as long as possible to provide a sufficient retirement income later in life. Tax free cash would stay at 25 per cent at State Pension Age, but with a higher rate if left longer and lower rates if drawn earlier. We also believe the pension system should recognise that there is a need to encourage savers to provide for their very long-term needs and our proposed system includes an additional annual allowance where contributions are applied to secure later life income or to meet the costs of long-term care.”
Altmann says: “Anyone using a Lifetime Isa, instead of a pension, is likely to end up with less in later life: Private pensions are far better than Isas in terms of their behavioural design. Using a pension, instead of a Lisa, should ensure you have more money in later life. Future governments will have to deal with the consequences of more poor pensioners, and greater strains will fall again on younger generations.
“Pensions have many advantages over Isas: Pensions can give you free money from your employer, more Government contribution to your savings, controls on the charges, better investment options for long-term growth and behavioural nudges to stop you spending the money too soon. The pension can pass on tax-free to your loved ones, or can keep growing as you get older and provide a fund to help pay for care if you need it as you get older.
“Using Isas will mean less money in later life. Isas are more likely to be held in cash – giving lower long-term returns, have no controls on charges and encourage you to take all the money as soon as you can, unlike pensions which have incentives to stop you spending the money too quickly.”
Rachel Vahey, product technical manager at Nucleus says: “With the introduction date for Lisa fast approaching, much of the detail remains unclear. For some, Lisa will provide them with an effective way of saving for their goals – whether that’s their first house or their later life. But it won’t be suitable for all.
“Getting regulated advice could help many make key decisions about whether to save within a Lisa. To help people access advice we would like advice charging to be a charge-free withdrawal, instead of having to pay a 25 per cent charge. This could mean investors getting the help they need, and paying for it the same way they do for other Isas and pensions.”