With the pensions revolution delayed, where next for savings policy?
Just as people can run in to difficulties when deciding how to manage their private pension pots, so too can Chancellors when setting the rules that govern them. A recent Treasury consultation on the best way to incentivise pension saving through the tax system led to consideration of moves to a “flat-rate” system of tax relief, or the introduction of a “Pension ISA”. Both were radical options, and the consequences of each approach for savings rates, fairness in redistribution, the pensions industry, and the public finances, were being aggressively debated before both ideas were seemingly dropped a few days ago. There may still be some small scale changes to pensions policy in next week’s Budget, but wholesale reform appears to be off the table for now. Nevertheless, the Government can still reasonably claim it has already made good progress towards its aim of, “…fostering a strong culture of saving”, and there are other ideas it could look at to take it further.
Saving is obviously not just about pensions. In addition to funding retirement, the motivations for putting money away vary from leaving an inheritance, to financing large purchases, such as a house or holiday, to protecting against a sudden drop in income, to smoothing financial resources over a period of time. There will inevitably be trade-offs at play between some of these motives; a younger person, for instance, may decide that at their stage of life it is better to build up a deposit to get a mortgage rather than save into a pension. For those that have the ability to save, there will also be a number of factors that influence the level at which it occurs. To name just a few, liberalisation of financial services can make credit more available and consumption easier, macroeconomic uncertainty can encourage people to buffer against the increased risk of losing their job, and interest rates dictate the returns somebody will realise from their stock of savings and from their current unspent income.
On this basis, public policy can both directly and indirectly influence a person’s savings decisions. For example, policymakers could sway the numbers of people saving for a house deposit by both offering top-up subsidies to first time buyers (as the UK has done), and by capping loan-to-value ratios offered by banks (as several European countries have done). But rather than interventions such as this focussed on one particular type of saving, the most successful initiatives in recent years have arguably been those offering generic paths down which a person can easily accumulate pots of money. The tax-free wrappers that are ISAs now have almost 23 million users, and the response to auto-enrolment workplace pensions has so far been good (although, there is a long way to go to truly judge, and many believe contribution rates to be too low).
Despite these positives, there is a constant battle to make people aware that these paths exist, and to aid understanding of how the products could be of benefit. To this end, auto-enrolment has recently been backed by a DWP advertising campaign featuring an enormous purple monster. The ads may well resonate with people, but there are potentially some more savvy ways that the Government can repeatedly communicate the purpose of its savings policies.
Many argue that changes in language and terminology could offer simple way of improving engagement with the savings system. While this may sound like tinkering, effective use of labelling to change perspectives and behaviour has some mileage. The Institute for Fiscal Studies says there is strong evidence that the “Winter Fuel Payment” is devoted more than other sources of household income to domestic energy costs. Two years ago a Conservative MP tried to rename National Insurance as the “Earnings Tax” on the premise that the public would have a better understanding of what it represented, which could in turn smooth the way for its merger with Income Tax. The “Christmas Bonus” – a £10 annual payment to pensioners that has been left more or less unchanged for forty years – cannot be reformed because of the political sensitivities of it being associated with the festive period. Numerous voices in the financial industry have advocated that the Government highlight how it “matches” pension contributions, with the Association of British Insurers calling for a rebranding of pension tax relief as the “Savers’ Bonus”.
Even if the messaging is improved, however, its effectiveness could be limited if there is not some degree of policy stability to accompany it. There have been a huge number of changes to the way private pensions have been regulated and taxed over the last twenty years or so, and some live long in the memory. People are still writing about Gordon brown’s 1997 decision to abolish the tax credit on dividends, which damaged the value of retirement funds. The upshot is that somebody who is now 45 – a decade away from making a decision about how to drawdown their pension saving – may reasonably conclude that there is no point in trying to make a plan when it is likely that the goalposts will have shifted again by the time they come to implement it.
Of course, stability should not negate big policy shifts, and when the Treasury comes to consider where to go next on savings policy it should ask if the potential benefits of stability are better than the potential benefits of change.