To save or not to save? That's the question

To save or not to save? That’s the question

But it is a question, which governments can make much more difficult for the individual to answer. That is, despite the fact that governments throughout the western world in particular are committed to encouraging people to save, and in particular, to save for retirement. With the looming threat of an increasing proportion of the population over retirement age and rising costs of state pension provision, governments seek to encourage private saving. But people show little sign of increasing their savings, little understanding of the costs of private pension provision and are not aware of how long they are likely to live.

Apart from tax incentives, two other conditions must be fulfilled in order to encourage saving (where people have sufficient disposal income to do so): trust and simplicity. The structure of the basic state pension should be simple, so that people can understand how much they will receive and can trust the government to provide it. State pension provision in The Netherlands meets these requirements: the pension is a flat-rate pension based on meeting the residency qualification and individuals receive an annual statement of how much pension they will receive.

Here is a lesson in what not to do, drawn from the whole experience of the UK, especially over recent years. The focus here is on government actions and how they have undermined confidence and trust. First of all, there have been frequent changes in the state pension scheme, which is both opaque and complex. The government abandoned the minimum income guarantee, which had only been introduced in 1999 and replaced it with a means-tested benefit, called “pension credit” designed to give low to middle income pensioners aged over 60 more resources, to reward pensioners for having saved in the past and to encourage people of working age to save for retirement. A single pensioner aged 65 or over in receipt of the full basic state pension is guaranteed an income of £114.05 per week and is “rewarded” for savings of up to £17.88 a week,where the “reward” means that the marginal rate of withdrawal of 40 per cent instead of the previous marginal rate of “tax” of 100 per cent. The first £6,000 of savings is disregarded but for any amount after that the government assumes that each £500 produces an income of £1 per week. Clearly, the treasury should tell us where savings can gain returns at that level. The effect of this complex system of means-tested benefits is that there is little or no incentive for people on low to middle incomes to save at all, and advisers are chary of recommending pension savings to those who are likely to be eligible for pension credit. But no one can be sure that the system will continue in the event of a change of chancellor. This also serves to undermine trust in state provision.

If state provision does not offer simplicity, then the situation with private pensions is even worse. Here too, the scene has been in a state of flux. Insurance companies were encouraged to provide a simple form of pension provision, the so-called stakeholder pension, but were obliged to do with a 1 per cent charge, which meant that the provision of a pension could not be accompanied by financial advice. Stakeholder pension did not catch on, as indeed the industry had warned the government.

The government commissioned another report on pension simplification and eventually introduced many of the recommended changes. In fact, these were introduced on 6 April 2006. The government did not allow any time for companies to prepare for the introduction of the new rules and regulations, since some of the final rules and regulations were released on “A” day. However,practitioners were in for another shock. Previously there had been eight pension schemes and now these were all to be reduced to one scheme – a sensible move. The new tax rules and regulations were finally published on A-Day, 6 April in the Registered Pension Schemes Manual but whereas the old manual covering eight schemes ran to 450 pages, the new “simplified” manual runs to well over 900 pages! So there is still no simple method of saving for a pension.

Pension providers, the insurance companies, have not inspired trust in the public mind either. The pensions missellling episode of the early 1990s, which continues to cast a long shadow in that restoring pensions to those who had been missold pensions took much of the rest of the decade. For that, insurance companies have only themselves to blame. But the government’s constantly changing pensions policy since 1997 has created many problems for the industry as well. It takes time to provide new products and/or apply new rules and regulations, which have little to do with regulations imposed by Brussels or the UK Financial Services Authority.

The 2006 Budget brought further woes, once again due to tax changes. The chancellor has seemingly ignored the famous Scottish economist, Adam Smith:“The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought to be clear and plain to the contributor, and to every other person.”Such a principle has flown out of the window. The tax system relating to savings is subject to arbitrary changes, so that what are tax efficient savings one day cease to be that the following day, prompting the question: does the government really want people to save or not?

The 2006 Budget was accompanied by a series of changes to trusts both without consultation and are retrospective in its effects on inheritance tax. Lawyers,accountants, and life insurance companies united in condemning the new levy on trusts. Lawyers ceased to write wills and insurance companies froze the sale of life insurance policies written in trust until the government, which had not consulted any of the relevant professionals bodies, took on board those who would be adversely affected by the changes. For example, trusts involving spouses may be written, where a husband wants to ensure that, in the event of his early death, that his wife is financially secure but that the capital eventually passes to his own children rather than to nay future husband his wife may have. They are also used to protect children by only allowing them restricted income and not the capital until they are 25, as opposed to 18.

The real concern here is not so much the details of tax changes as they apply to trusts, but the fact that the finance bill applies all such changes retrospectively in a measure which undoubtedly undermines confidence and trust in both the government and, indeed, in contracts. Savings, especially long-term savings, are contractual in nature. If the terms of the savings contract can be overturned at any time by the government of the day quite out of the blue, then inevitably individuals will be hesitant to enter into contracts and advisers,whether accountants, lawyers or providers of financial services will be reluctant to offer advice. The consequences of retrospective legislation are even deeper than that. It undermines the rule of law, and when that appears not even to be understood, then the implications for the conduct of financial services business are alarming indeed.

Oonagh McDonald