The Chancellor has launched a pension alternative in the shape of the Lifetime Isa but is being prevented from carrying out wider reform by concerns over the Brexit vote. So what is likely to be his next step and what can we divine of his plans for the future from what he has done so far? John Greenwood reports
Viewed until recently as one of the most politically astute chancellors the country has ever had, George Osborne has made a habit of deriving capital from pension policy. Whether through multibillion-pound savings achieved by reducing the annual and lifetime allowances, increased tax receipts from pension freedoms or happy retirees liberated from having to buy an annuity, Osborne has historically done well out of reshaping the retirement savings framework.
Now that he is being held back from tapping the pensions well, things seem to be going differently. Blocked from making a radical shift to a pension Isa system – for the present at least – because of fears of upsetting core voters ahead of the Brexit referendum, Osborne has seen his sums knocked seriously out of kilter. While last November’s Autumn Statement saw him using a £27bn ‘windfall’ to put the brakes on austerity, the Office for Budget Responsibility now thinks it likely he will miss his surplus target.
The launch of the Lifetime Isa earned him some positive headlines – part of a concerted attempt to connect with the younger generation – and he has potentially published the blueprint for a future retirement savings system devoid of pensions tax relief. The fact that he has spent, not saved, money on long-term savings policy – the Budget documents calculate that the cost of the Lifetime Isa and the increase in Isa limit to £20,000 will stack up to £1.94bn by the end of the Parliament – surely indicates unfinished business.
“The Chancellor has reaped no savings yet and you can be damn sure he is keen to do so, given the macro-economic environment,” says Centre for Policy Studies fellow and keen proponent of a switch to pension Isa Michael Johnson.
“None of the rationale for refashioning tax relief has gone away and there is little doubt that within 12 months there will be another change to the taxation of pensions.”
For the pensions industry the stakes could not be higher. The Treasury has, through tax relief, injected over £300bn into private pension pots since 2002, a source of assets that will shrink significantly overnight if a pension Isa model is adopted. Yet understanding what the Chancellor is really thinking, and predicting if he will remain in post long enough to execute his plans, is not straightforward.
Johnson has been making accurate calls on Treasury pensions policy for some time; his letter printed in The Times on the Friday before the Budget used the exact phrase ‘Lifetime Isa’. He sees this as the first stage to a switch from Exempt, Exempt, Taxed to Taxed, Exempt, Exempt for all pension savings – more than paid for by the abolition of tax relief.
“The Lifetime Isa is the first building block of that transition. The bigger piece of work is to accommodate auto-enrolment in an Isa framework,” says Johnson.
He believes the next step is a workplace Isa, operating on a similar basis to the Lifetime Isa, potentially with a more generous government match, allowing younger savers to make withdrawals for a first home purchase or, with the loss of the bonus, to spend as they wish.
But such a momentous switch will still require deft political work, with a solution needed for DB, the headache of running parallel systems and a lot of higher earners likely to be angry at the loss of significant tax perks. The ending of the totemistic tax-free lump sum would be a challenge for any Chancellor.
“A switch to a TEE solution means the abolition of the tax-free lump sum and of tax relief,” says AJ Bell head of platform technical Mike Morrison. “These are things that people have got used to.”
Morrison also points to the potential accusation of short-termism the Chancellor could expose himself to. Osborne appears to have absorbed the view that ‘people like Isas’ – he said as much at the dispatch box during his Budget speech. If the workplace Isa allows the same ease of access to cash as the Lifetime Isa, Osborne will be accused of overlooking the well-understood behavioural bias of hyperbolic discounting if withdrawals are significant. He can also expect to be accused of pouring fuel on an already overheated property market.
“Being a society that prioritises consumption over saving, particularly consumption of property, all this policy will do is point people in the wrong direction, forcing up house prices,” says Morrison.
But the financial prize for Osborne may be too attractive for him to let these problems hold him back. If he is still around to finish the job, a switch to pension Isa across the board looks likely, giving him the funds to repair his reputation. And if he is not, his successor will have to take a view.
The Westminster insider’s view
Executive chairman, Cicero Group
In July 2015 Osborne launched the consultation on taxation incentives because he was excited by the idea of radical reform. But this goes back a long way, to the mid-noughties when David Willetts was rolling around some of these ideas before the 2005 election. They resurfaced in 2008–09 and, if Osborne had been in a Tory-only government in 2010, this retirement income taxation revolution would have happened a lot earlier.
Osborne has also seen the effect freedom and choice has had on his political fortunes, reconsolidating his standing both in Westminster and in the country at large. So he has seen the pension revolution work for him.
The numbers were sent to the Office for Budget Responsibility to allow the Treasury to plan in the Budget for either a fundamental move to a pension Isa or just a boost to pension tax relief. The OBR also had a look at the macro effect on public finances.
Then a couple of weeks ago tabloid pressure, driven by Tory MPs in the shires worried about their core vote, meant that the pension revolution was suddenly off the agenda. Supposedly. Until the Budget. As soon as I heard about the Lifetime Isa, I tweeted: ‘Wow – the pension revolution continues.’
Osborne has taken pension and taxation reform as far as he can within the backdrop of the EU referendum and with the Parliamentary party being restive.
I think the Lifetime Isa has laid the foundation of what he will eventually do – if he is still Chancellor next year. That is to say, he will bring in a system where anyone over 40 won’t be able to do a Lifetime Isa but if you are up to 40 you will.
We saw in the Budget a lot of talk about the younger generation. The Government has clearly decided that age 40 is the pivotal point where people are less interested in pension and more interested in Isa.
But the answer to much of this will come on 24 June. If Osborne finds he will not be in situ much longer, it may prove irresistible. But there may soon be other people in charge who think it is easier to leave things as they are, in which case the pension revolution may come to a juddering halt.
George Osborne on pensions versus Isas
“The fundamental problem is that far too many young people in their 20s and 30s have no pension and few savings. Ask them and they will tell you why.
It’s because they find pensions too complicated and inflexible, and most young people face an agonising choice of either saving to buy a home or saving for their retirement….
My pension reforms have always been about giving people more freedom and more choice.
So, faced with the truth that young people aren’t saving enough, I am today providing a different answer to the same problem.
We know people like Isas because they are simple. You save out of taxed income; everything you earn on your savings is tax-free; then it’s tax-free when you withdraw it too.”
Budget speech, 2016
The Lifetime Isa
From April 2017 anyone under the age of 40 will be able to open a Lifetime Isa and save up to £4,000 each year.
For every £4 saved, the Government will give £1 a year until age 50.
Unlike a pension, the inves-tor’s own contributions plus growth can be accessed at any time without the bonus, subject to a 5 per cent charge.
The Treasury is also consulting on whether, like the US 401K, individuals will be able to return money to the account to reclaim the bonus.
Those who have already taken out a Help to Buy Isa will be able to roll it into the new Lifetime Isa and keep the government match.
The think-tank expert’s view
Centre for Policy Studies fellow Michael Johnson
There is still a fundamental debate to be had regarding the appropriate incentive. At the moment, it is clear the incentive principle is being adhered to. If the current incentive is not sufficient, maybe it will be ditched altogether.
But for the next few years we will have to go along with some form of upfront incentive to get people to put their money away. I would like to see the incentive doubled, to £2,000. This could be funded by cutting higher-rate tax relief, which seems logical. We may see something further in the Autumn Statement or next year’s Budget.
The Lifetime Isa as proposed leaves a question around NICs and salary sacrifice. I’m surprised Osborne did not address this in the Budget but we are in a unique situation with the referendum, which is why he pulled away from the pension Isa. The Lifetime Isa is a clear template for what will be considered its logical counterpart, the workplace Isa.