The Conservatives are in danger of slipping into another inheritance tax-style trap with their proposals for pension reform.
While the Tories' plans on pensions are in many respects very sensible — and, in fact, far from out of step with the Government — one eye-catching proposal could end up being seen as another gift to the wealthy.
In addition to publishing some well-meaning ideas for new pension policy, shadow Work and Pensions Secretary, Theresa May, yesterday pledged to drop the requirement for people with private pensions to convert their savings into income by buying an annuity at age 75 at the absolute latest.
This will be a familiar notion to anyone who has studied pension policy developments over the past decade. A small but vociferous campaign for exactly this reform has been one of the most consistent thorns in the side of the current Government — so much so that ministers actually gave them what they wanted five years ago, only to change their minds when it became apparent that some savers were trying to exploit the system.
People object to buying an annuity because they don't like being told what to do with their own money. Moreover, while these products offer a safe income for life, they do carry risks. Not least, you're stuck with the prevailing annuity rate at the moment you retire (a poor deal at times such as now when rates are close to all-time lows). Also, if you die even just a single day after buying an annuity, your savings are lost for good — in very simple terms, the maths of the market tell you that at best, only 50% of savers get more income back from an annuity than the value of the savings they handed over.
Why then, do governments insist on maintaining compulsory annuity purchase (previous Conservative administrations did too)? One answer is that if there weren't some rules about how people used their pension savings, there would be nothing to stop you frittering them all away in the first few years of your retirement. That's not just a nanny-state issue: having spent their pension funds, savers would be dependent on state benefits, which would be difficult to stomach even if you forgot about the huge tax breaks given to people as they build up their nest eggs for retirement.
The second issue is that many of those who campaign loudest for an end to compulsory annuity purchase have a hidden agenda. What they really want is to find a way to pass on unused pension savings to their heirs — ideally with the minimum deduction possible made for inheritance tax.
Never mind that savers get very generous tax relief on pension contributions at their highest marginal rate of tax — and thus that a substantial proportion of their pension funds consists of unearned income. They'd like to be able to pass on this cash to heirs — and to deprive the Treasury of the income tax that is due on annuity payments.
Naturally, the financial services industry is only too happy to help, and regularly devises devious schemes — all in the name of product innovation — that are aimed at exploiting any perceived weaknesses in the rules. This is why previous attempts to introduce some flexibility into the annuity regime have so often floundered.
No doubt Ms May will argue that the Conservative intention to scrap compulsory annuity purchase is a step back from nanny-state regulation, an attempt to offer pension savers greater freedom in their retirement. That sounds very sensible, but the truth is that scrapping compulsory annuity purchase is a move that would benefit a tiny minority of people — those who are wealthy enough not to have to depend on pension savings in retirement and would like to have the freedom to explore ways of minimising what tax they pay on this money and passing it on to others.
That's why this proposal could be another inheritance tax policy in the making. It is an attempt to appeal to middle class voters that will, in fact, turn out to be useful only to a privileged few. Like those Tory inheritance tax proposals, it could prove to be a valuable tax break for those people who least need it.
And, as less well-off savers make the mistake of thinking annuity purchase isn't for them either, there's a good chance the State — taxpayers, that is — will have to pick up the bill for bailing out savers who run out of money during retirement, even though a good chunk of their pension fund was paid for by tax breaks in the first place.