Rethinking retirement saving incentives

Michael JohnsonResearch Fellow, Centre for Policy Studies

www.cps.org.uk

2

Central projection for PSND to GDP (%)

* OBR’s Fiscal Sustainability Report July 2013 ** OBR’s Fiscal Sustainability Report July 2014

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1970 1980 1990 2000 2010 2020 2030 2040 2050 2060

99% in 2062 - 63

66% low (mid 2030’s)

Ratio excludingimpact of ageing population (approx.)

53% low

84% in 2063 - 64

OBR’s

FSR

July

2013

OBR’s

FSR

July

2014

PSND, £ bn. 2013 2014April – August £42.8 £45.4

3

We face a personal debt crisis

Source: Bank of England

* Incl. credit cards, motor and retail finance deals, overdrafts and unsecured loans

MortgagesConsumer

credit * TotalPersonal debt £1,280 billion £159 billion £1,439 billion

Average debt per household £48,454 £6,018 £54,472

Average debt per adult £25,505 £3,168 £28,673

Interest paid per household - - £2,242

Savings (2012) and demographics

Population aged 65+

UK Japan1950 10.7% 4.9%2010 16.5% 22.6% 2050 22.9% 37.8%

OECD; National Accounts at a glance 2014. Definition for HNSR: the ratio of household saving (plus the change in net equity of households in pension funds) to household disposable income.

Household net Net debt

saving rate as % GDP

Greece -14.6% 102%Japan 0.8% 140%

United Kingdom 2.4% 69%Italy 3.6% 113%

Netherlands 4.1% 42%Spain 4.4% 60%

Canada 5.0% 59%Ireland 5.2% 83%

United States 5.8% 100%Norway 8.2% -167%

Germany 10.3% 50%Australia 10.4% 27%

France 11.7% 70%Sweden 12.2% -24%

5

Ageing population / fewer workers per pensioner

+ Stagnant productivity growth

+ Rising interest rates (2015+ ?)

= Fiscal squeeze

+ Approaching saving tipping point

= Diminishing supply of domestic capital

Cost of capital to rise

We need a savings culture……but……

The squeeze is on

Retirement saving: contributions, £ bn.

Employers Employees Assets

Occupational £64.1 £14.4

Personal £9.9 £7.7

SIPP & SSAS - £6.0 c. £100

£74.0 + £28.1 = £102.1 £2.1 trillion

c. £2,000

Personal pensions

Stocks & shares ISA

ISA market value

2007-08 £10.2 £10.4 £1462008-09 £9.0 £9.7 £1162009-10 £7.8 £12.5 £1742010-11 £7.7 £15.5 £1832011-12 £8.7 £15.6 £1892012-13 £7.7 £16.5 £222

Subscriptions

(+ £220 Cash ISA)

Tax relief, 2012-13, £ billion

£270 billion of cash since 2001-02

HMRC; Table PEN 6: Cost of Registered Pension Scheme Tax Relief, February 2014

Up-front tax relief on employer contributions £21.3Up-front tax relief on employee contributions £6.7

Tax-exempt 25% lump sum at retirement (approx.) £4.0NICs relief £15.2

Untaxed pension products' income £6.9Total £54.1

less pensioner income tax £11.5= net cost to HMT £42.6

Not deferred tax !

8

Not deferred tax: many 40%ers only pay 15% i/c tax…..

.......and decades later

Tax relief: inequitable distribution

Income tax is progressive..

…..so tax relief is regressive

Income decile

% of total tax relief

Corresponding annual income*

Bottom 1%2 1%3 1% < £23k4 2%5 3%6 4%7 6% £23k8 8% to £45k9 17%

Top 58% > £45kTop 1% 30% > £100k

Top 0.5% 22% > £150k* approx

HMRC; Personal Incomes Statistics 2011-12, January 2014

9

Behavioural considerations: Denmark

DKr1 of gov’t spend raised total household saving by DKr0.01

Tax relief ineffective in increasing the nation’s savings

Q: Is UK very different?

Active savers (15%) Passive savers (85%)

Behavioural driver

Save anyway: alert to seizing tax incentives

Automatic (default) policies harnessing inertia: AE

Impact on total h/hold saving

Minimal increase: savings reallocated

Significant increase

Cost: Huge per capita Small

10

Tax relief: policy options

• Recent

• AA: £255k…….£50k…...£40k….?

• LTA: £1.8m….£1.5m ….£1.25m…..?

• 25% tax-free lump sum?

Savings

2012-13 £2.3 bn

2013-14 £4.4 bn

Post-tax £ tax reliefFlat rate contribution from HMT Pot total Communication33.3% £100 £50.0 £150.0 £2 for £1 “free”30% £100 £42.9 £142.9 £7 for £3 “free”25% £100 £33.3 £133.3 £3 for £1 “free”20% £100 £25.0 £125.0 £4 for £1 “free”

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• Scrap all tax relief 50p per £1 subscribed

• Independent of taxpaying status

• Max. £4,000 from HMT: focused on first £8,000 savings

• Simple…… and highly redistributive

Tax relief: proposals to boost effectiveness*

* Retirement saving incentives: the end of tax relief, and a new beginning, MJ, April 2014

• £30,000 annual contributions limit

• 3 quid pro quos:

But……..Generation Y……..

1. Scrap LTA

2. Re-intro 10p rebate on dividends

3. £100k IHT exemption on transfers to pension pots

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• Combine today’s 4 ISAs + CTF

• Cradle (+£500) to grave

• HMT incentive……shared with pension products

• Withdrawal rules: some ready access….to capital only

• Round tripping mitigation

• Tax

• Nudges to promote default-based saving

• Default fund / income accumulation / AE

Time for the Lifetime ISA*

* Introducing the Lifetime ISA, MJ, August 2014

Lifetime ISA vs. pension product

Lifetime ISA Pension products

HMT 50p incentive Yes Yes

Pre-60 access Yes, but first repay 50p per £1 withdrawn

Pre-55: none

60+ access Yes, taxed at marginal rate 55+: tax at marginal rate

Access to capital growth None until age 60, then Pre-55: none& accumulated income taxed at marginal rate 55+: tax at marginal rate

Tax-free 25% lump sum No YesCharge cap on default fund 0.35% p.a. 0.75% p.a.

Interaction with m-t benefits Treated as capital ExemptPart of estate for IHT ? Yes No

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Default fund design: passive

Portfolio turnover

UK Large Cap

Balanced fund

Global Equities

Emerging Markets

Multi- Manager

10% 0.2% 0.1% 0.2% 0.8% 0.3%50% 0.9% 0.5% 0.8% 3.8% 1.3%

100% 1.8% 1.0% 1.7% 7.6% 2.7%200% 3.1% 1.9% 3.0% 11.0% 4.9%

• Costs

Av. annual trading costs 1.25% - 1.40%

Weighted av. TER* 1.56% - 1.66%

≡ 66% of 4.5% equity risk premium

• The tyranny of turnover: performance drag**

c. 3% p.a.

* 1.56% from IMA press release, 27 January 2012, for active retail UK equity funds, 1.66% from Lipper** Data: Frontier Investment Management

15

F&C consistency ratio: performance over 3 x 12 months

The IMA’s 12 major market sectors: 1,086 funds (end-Q2, 2014)

Active fund managers: no value-added?

Daniel Kahneman: “there are domains in which expertise is not possible. Stock picking is a good example”

Warren Buffett: “By periodically investing in an index fund, the know-nothing investor can actually out-perform most investment professionals”

Outcome Luck + Skill "Fail"Top quartile 25 (2.3%) 17 (1.56%) 8 (0.7%) 1,061 (97.7%)

Top half 138 (12.7%) 136 (12.5%) 2 (0.2%) 948 (87.3%)

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• Capital crisis coming

• Tax relief: the lowest hanging, juiciest fruit in Whitehall?

• The Great Trade

• Lifetime ISA to formally bring ISAs into the retirement arena

• Chameleon, with saver in control

• What future private pensions?

Conclusion

Rethinking retirement saving incentives

Michael JohnsonResearch Fellow, Centre for Policy Studies

www.cps.org.uk