Labour would be mad to oppose Osborne’s pensions liberation
SUPPORTERS of the nanny state were out in force yesterday, attacking George Osborne’s revolutionary liberalisation of the pensions market. Starting next year, the chancellor will no longer force savers to hand over pension pots to insurers in return for a miserable income for life, a so-called annuity.
Instead, savers will be able to use the money – their money – as they see fit. It’s an extremely powerful quasi-libertarian policy, and one which has caught Labour by surprise. While the party hasn’t officially said what it thinks of the idea yet, some of its more vocal supporters have been criticising it, arguing that people cannot be trusted to look after themselves. As vote-losing arguments go, telling voters that politicians, not the people, should be trusted to spend their own money takes some beating.
The simple reality is that many of the arguments used against the pension reforms don’t stack up. We are told that people who have spent decades patiently saving money in a pension will suddenly take it all out and blow it in one fell swoop. But that would make no sense: money taken out of the pension will be treated like any normal income and taxed accordingly.
So imagine you’ve somehow managed to build up a £500,000 pension over many decades. Under the current rules, which won’t change, you can withdraw a quarter – or £125,000 tax free – when you turn 55, leaving £375,000 in the pot. No change there. But now, instead of having to use the rest to buy an annuity, you will be able to withdraw the cash as you see fit. This is driving the paternalists into a frenzy of rage – how on earth can people be trusted, they ask indignantly.
But if you were stupid enough to empty the rest of your pension in one day, perhaps to purchase a property or to travel round the world, you would end up paying 45 per cent tax on £225,000 worth of the cash, 40 per cent on £107,715 worth of it, and 20 per cent on most of the remainder, with no zero-rated personal allowance at all. The combined bill for giving up on deferred gratification would be crippling. If instead you withdrew £10,500 a year, you would pay no income tax at all; and if you kept your annual withdrawal to £42,285, you would pay the basic 20p tax rate on the value above the personal allowance. In other words, because of the graduated income tax system, there is a huge incentive for people to spread their income drawdown over time. The critics are simply wrong about this – virtually everybody with large pots will be prudent.
The other big argument is that the burden on the state would be increased if people lost all their money. There are three responses here: first, millions already depend solely on the state for all of their income in retirement. Second, a more attractive savings system would cut the number of people entirely dependent on taxpayers, even after accounting for those that lose everything. Third, the government is introducing a single-tier pension from April 2016. Crucially, it will not be means-tested – almost everybody will be entitled to it. So whether somebody blows their private pension or not will not make any difference to pension expenditure – but it is true that in some cases it could lead to extra council tax and housing benefit. Some modest moral hazard remains.
There is another reason why people would want to keep money in their pensions: investments are exempt from capital gains and some other taxes. What about the argument that annuities will become more expensive – because far fewer people will buy them, their only customers will be those expecting to live longer, pushing up their prices? That is true, but merely means that those who die earlier will cease to subsidise those who live longer. The market will be more efficient. There will, of course, be downsides. But Labour would be mad to jump on a paternalistic, nannying high horse and to oppose Osborne’s pension liberation.
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