2012 Budget Analysis

by Dr. Ros Altmann

(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)

---

IMMEDIATE RELEASE

Budget serves up more bad news for older people – how much can they take

Another take-away Budget but with a bit of good news too!

There was plenty of bad news for older people in this Budget:

Shock rise in age allowance hits middle-income pensioners – poorest and richest are unaffected: The big shock in this Budget was the astonishing stealth tax announced for 5 million of Britain’s middle class pensioners. Any pensioner with income between around £10,000 and £24,000 a year will pay more tax in future than they would have done without this change. The Government says this is a measure to ‘simplify’ the tax system – and it is true that the age allowance is very complicated – but the reality is that this is really just a revenue-raising exercise. People reaching age 65 in the next couple of years will be £4 a week worse off as a result of this measure. If their state pension had been reduced by £4 a week there would be uproar, but abolishing the age allowance has a similar effect – although only for the middle income pensioners. The very poorest and very wealthiest are not affected, because the age allowance is phased out once older people’s incomes reach around £24,000 a year. So it is the decent middle income pensioners, who worked hard and saved hard to have a bit of extra income in later life – the very people that we should be valuing highly – who are hit by this move. The Office for Tax Simplification report did point to the complexity of the age allowance, but recommended that, if it were removed, other measures could be introduced to offset the income reductions for pensioners. The Chancellor chose not to listen to this and just removed the allowance.

Nothing for savers:
There was nothing in this Budget to help savers, especially older people trying to live on the income from their savings. The policy of ultra-low interest rates for the last three years, has hit savers hard and there was still no help from the Chancellor. The very least he could have done would have been to relax the restrictions on ISAs that mean older savers cannot put their full annual ISA allowance into cash savings. At the moment, only half can be in cash, with the rest having to be put into more risky shares or bond investments. The Chancellor should allow older savers, who may not be able to afford to gamble their lifetime savings on the stock market, more flexibility to decide what type of savings are best for them, rather than being denied a choice and forced to take risk in their ISA. More flexibility and choice would be far better for older savers, helping to offset some of the damage done by ultra-low interest rates and would have softened the blow of the abolition of the age allowance, allowing people to keep more of their meagre interest income tax free would be far fairer than adding insult to injury by taxing them even more! There was no announcement about new incentives to help people save for later life care needs either. It seems that savers simply do not matter to the Government. The message it is sending to the population is that those who save are valid targets to take money from, while borrowers are baled out.

Nothing to mitigate the damage caused by Quantitative Easing and high inflation – annuities, income drawdown and pension funds all hit with no relief in sight:
There is precious little evidence that Quantitative Easing (the Bank of England’s policy of creating billions of pounds of new money to buy up Government bonds) has actually stimulated the economy, but there is plenty of evidence that it has done dreadful damage to pension funds, pensioners and annuities. By buying so many gilts, the Bank of England has forced long-term interest rates down, but has not kick-started huge amounts of help for the small firms that are the lifeblood of a growing economy. QE was meant to be a ‘temporary’ policy to avoid economic meltdown and stimulate the economy. Unfortunately, the policy is still in place, even though deflation and depression are no longer on the horizon. In fact, this temporary policy has permanently impoverished over a million pensioners already, with more facing the same fate each week. Nearly half a million pensioners buy annuities each year, and the lower the interest rates on government bonds, the lower annuity rates fall and the less pension income people will receive for their pension savings. Since QE started, annuity rates have fallen by 20%, so pensioners face a fall in their lifetime pension by a fifth – and this is a permanent reduction, because once the annuity is bought it can never be changed. In addition, the annuities being bought are almost all ‘level’ annuities, which offer no protection against inflation. The income stays the same for the rest of the person’s life. Therefore, the current high levels of inflation are continuing to whittle away these pensioners’ purchasing power. There has so far been no recognition of this problem and the Chancellor continues to consider very low Government bond yields as an unalloyed benefit for the country. This is not the case. Annuity rates have fallen by a fifth, inflation for older people has risen by over a fifth and pension deficits have increased by more than £90bn, largely as a consequence of QE. Measures to help alleviate these problems are needed urgently before our pension system is further undermined.

Perpetual and 100-year gilts not good for pension funds, try longevity gilts instead:The Chancellor’s announcement of a consultation on issuing 100-year gilts seems more of a gimmick than a useful tool for pension funds to consider investing in. One has to wonder why pension funds would want to buy 100-year gilts at all, but especially not at current yield levels. Today’s pension fund and annuity liabilities do not have a 100-year time horizon and, after the Bank of England has just been buying up a third of the outstanding stock of gilts, artificially depressing long-term interest rates – pension investors would be reluctant to lock into current rates for so long. It would be far more helpful to pension funds if the Government were to issue longevity gilts, rather than ‘century’ bonds. Longevity gilts would pay an interest rate dependent on rises in life expectancy, which would allow pension schemes and annuity providers to better match their liabilities.

So that’s the bad news, but there were actually some pieces of better news:

Radical state pension reform at last:
A long overdue and very welcome announcement was that there will be radical Sate Pension reform. This is great news and there will be a Consultation later ‘this Spring’ on a flat rate state pension of around £140pw, above the means-testing level. This would merge the Basic State Pension with the State Second Pension in future and this new state pension will still be based on contributions paid in, finally moving us towards a system without mass means-testing for pensioners. Of course, we need to see the details when the consultation comes out, but if introduced correctly, this measure could end the penalty suffered by those lower income pensioners who save for retirement or try to keep working in old age and find they lose much or all their extra income in the means-test.

No changes to pensions tax relief – great news for the pensions industry:
There was great news for top rate taxpayers, as the Chancellor announced he was not changing pension tax relief rules. The pensions industry will welcome this and it is a great chance for 50 per cent taxpayers to pile into pensions and contribute as much as they can this year – before the 50% rate is cut to 45% next year. 50% relief means anyone contributing £3 to a pension will get another £3 from taxpayers. Those on 40% tax will only get another £2 for every £3 they contribute, while basic rate taxpayers get about 80p extra for every £3 they contribute. By not changing pensions tax relief, the Chancellor has avoided more negative headlines about pensions. 2012 is a very important year for pensions, as all workers will start to be automatically enrolled into a workplace pension scheme, to which they and their employers will have to contribute unless the employee opts out. This would not, therefore, have been a good time for negative news on pensions. In fact, pensions confidence has collapsed, particularly in the private sector in the past few years. Official figures, released today, show that less than one third (only 32%) of private sector workers are in a workplace pension scheme. So any measures that would further reduce the attractiveness of pensions would be unwelcome, if the Government is really serious about encouraging pension provision.

Good to see pension funds assets being harnessed to stimulate the economy:
Another welcome announcement is that the Chancellor will be using pension fund assets for major national investments, with a Pension Infrastructure Platform providing investment in long-term projects to modernise our outdated infrastructure. Harnessing the power of pension fund money to help stimulate the economy is a very sensible move. I would hope that many pension funds, not just the twelve already working with the Treasury on this, will be able to join in. Investing in infrastructure is a good way to stimulate the economy but is also potentially attractive asset for pension funds. Infrastructure projects, if successful, can offer inflation-linked returns and some capital appreciation for investors, which is an ideal return profile for pension funds.

Finally… We are very fortunate that we have so much money in pension funds, which is the result of people saving for retirement in the past. We must recognise the value that these assets bring to our economy and not take for granted the value of long-term saving. Policymakers please take note. Borrowing will not provide sustainable long-term growth – we also need to encourage saving and investment.

ENDS
Dr. Ros Altmann
21 March 2012