We live in fast-changing times – the world of work is radically different from a generation ago and people are living longer in retirement, which costs money.
The Government is currently consulting with pensions experts and members of the public on how to ensure the pensions system is future-proof and how to encourage pension saving. The results of this are expected to be published in the next few months.
But while we await the results of the consultation, I thought it worth explaining some of the key issues the Government is looking into and the backdrop to all this.
I know, I know, it might sound like a sure-fire cure for sleepless nights, but the outcome isn’t something to snooze through. It’s part of long-term changes, which have the potential to make us richer or poorer in years to come.
Changing pensions landscape
One of the key changes the Government needs to take into account is a shift from defined benefit (DB) to defined contribution (DC) pension schemes – see our Pension need-to-knows guide for more on how these work.
With DB schemes, a pensioner’s income is derived from factors such as their salary and their number of years of service, rather than how well their pension investments performed. This has resulted in a pretty good deal for many, but while some still have them, employers are decreasingly offering them.
DC schemes on the other hand see workers build up a ‘pot’ of money they can access in retirement. How well the investment performs ultimately affects the size of the pot.
Plus, new ‘pension freedoms’ introduced in April 2015 mean people with a DC pot have more choice over what to do with their money, as rather than purchasing an annuity to pay them a monthly income for life, they can choose to take a lump sum, for example.
How technology impacts pensions
We probably don’t stop and think about it often enough, but the way many of us get information on finance, choose products and services, and then manage our accounts is very different from even just a few years ago. And technological development is not slowing down.
This consultation is also taking place against this backdrop, so it’s essential that flexibility for rapid technological change is embedded into the pension reforms. The financial regulator even has a specialist unit focused on supporting innovative technology in financial services.
What the consultation is looking into
Here are some of the key issues the Government is consulting on:
1. Changing when pensions are taxed
A pension is an investment, and although it’s impossible to predict exactly how much it’ll be worth when you retire, many experts are concerned workers aren’t putting enough in to give them the lifestyle they want in retirement.
The way we’re incentivised to save in pensions is through tax rules set by the Government. Currently, under a system catchily known as Exempt-Exempt-Taxed (EET), tax isn’t taken when money goes into a pension, or when that pension grows, but when money is taken out of the pension in retirement – although up to 25% can be taken tax-free.
But one radical suggestion is to turn this system on its head so money is only taxed when it’s first put into a pension. This is known as Taxed-Exempt-Exempt (TEE), and works in a similar way to putting money into an ISA (see our ISAs guide for more on how these work).
Other changes, such as altering the lifetime and annual tax free allowances, have also been suggested.
2. Building on auto-enrolment
Automatic enrolment has been sweeping through companies since 2012 and is expected to end in 2017. Under the scheme, everyone in employment has to be automatically opted into a pension. They can opt out, but so far, the majority haven’t.
The Government wants to build on this so future reforms work alongside it, although it’s yet to explain how it will do this.
3. Simplifying pensions
Pensions can be a daunting thought for many, so the Government hopes to make things simpler and clearer, so more people will decide it’s worth saving for retirement.
4. Encouraging personal responsibility
The Government is looking for reforms that will encourage people to take responsibility themselves to plan and save for retirement.
5. Maintaining sustainability
This is a fancy way of saying pensions must fit in with the Government’s other plans for tax and spending. Essentially the Government doesn’t want to over-promise a pension system now, which it won’t be able to afford later on.