PPI. Increasing the value of saving in Personal Accounts: taking small pension pots as lump sums

Transcription

1 Increasing the value of saving in Personal Accounts: taking small pension pots as lump sums Chris Curry Pensions Policy Institute No 1 Great George Street 11 June

2 Taking small pension pots as lump sums Lump sums can already be used to improve returns from saving Increasing the trivial commutation and capital limits could increase returns from Personal Accounts But it may increase the cost of means-tested benefits to the taxpayer 1

3 Suitability of Personal Accounts Estimate returns from saving in Personal Accounts, taking into account the complex interaction with state pensions, tax and means-tested benefits Other factors besides the return are relevant, e.g. consumption smoothing, debt, affordability of contributions 2

4 Three risk-categories are used, based on the IRR Gets back own contributions + inflation Low-risk plus Investment returns plus Tax relief plus Employer contribution plus Investment returns on TR + E er P P Partial?? Medium-risk Partial 5.5% = investment returns P O O O High-risk Partial 2.5% = inflation O O O O 3

5 Returns from saving in Personal Accounts will vary between people Estimated internal rate of return and risk groups Paul 25 year-old median-earning man 5.8% Low-risk Kate 40 year-old woman with modest caring and part-time work Jasmine 25 year-old woman with non-standard employment Paul (renter) 25 year-old median-earning man who rents in retirement 5.2% 5.3% 1.6% Medium-risk High-risk

6 Who is at risk of finding Personal Accounts unsuitable? A dynamic model would be required to estimate the numbers of people in the different risk groups So difficult to say whether men or women are more at risk of low returns from saving in Personal Accounts: Men are more likely to be self-employed Women and men have a similar likelihood of renting in retirement But women are more likely to have low earnings and are less likely to be in work Women typically have lower amounts of existing saving Women over age 65 are more likely than men to be single 5

7 Policy options that could reduce the risk of unsuitability 1. Not auto-enrolling at-risk groups 2. Increasing trivial commutation limits to enable these groups to take their pension as a lump sum 3. Making pension saving fully or partly invisible to means-testing for these groups 4. Tailoring the generic advice given to these groups to enable them to make the right decision 5. Significantly cutting back the generosity of meanstested benefits 6

8 Small amounts of capital can be treated more advantageously than income for means-tested benefits All pension income is taken into account for means-tested benefits But the first 6,000 of capital (e.g. savings in a bank account) is not taken into account So taking a lump sum can mean that less of an individual s pension saving is taken into account for means-tested benefits

9 YES Pension fund less than 15,000? NO Can trivially commute and take entire pension saving as a lump sum 25% is tax-free The remainder of the lump sum is taxed as income Can take 25% of pension saving as a lump sum The lump sum is tax-free The remainder must be used to buy an annuity by age 75. The annuity is taxed as income

10 Tax-free lump sums can increase returns from saving Kate: 40 year-old woman with modest caring and part-time work Pension fund at retirement = 22,500 so cannot trivially commute but can take a tax-free lump sum Does not take a tax-free lump sum 4.3% Take lump sum, saves it, spends 5% of the balance each year 5.2% Takes lump sum, buys a voluntary annuity 4.4% Takes lump sum, spends it all immediately 5.6%

11 Spending a tax-free lump sum could lead to marginally lower income in later life Kate s total income (state and private pensions, capital drawn down and means-tested benefits), per week, 2006/7 earnings Spends tax-free lump sum immediately Weekly income 5 lower as result of spending lump sum Does not take a lump sum

12 Trivial commutation can increase returns from saving Jane: 50-year old woman with caring and part-time work Pension fund at retirement = 7,000 so can trivially commute Does not take any lump sum 4.1% Trivially commutes, saves it, spends 5% of the balance each year 7.2% Trivially commutes, buys a voluntary annuity 4.1% Trivially commutes, spends it all immediately 11.2%

13 Spending a trivial commutation lump sum could lead to marginally lower income in later life Jane s total income (state and private pensions, capital drawn down and means-tested benefits), per week, 2006/7 earnings Spends trivial commutation lump sum immediately Weekly income 4 lower as result of spending lump sum Does not take a lump sum

14 Trivial commutation would not increase returns for all Trivial commutation could make returns worse rather than better for people with non-pension saving (or whose partner has non-pension saving) Pension saving other than Personal Accounts (including contracted-out pension) may mean individuals cannot trivially commute their Personal Account Some people could be above the trivial commutation limit but still be at high or medium risk 13

15 Reform A Trivial commutation limit: increase from 15,000 to 30,000 Capital disregards for PC/CTB/HB: increase from 6,000 to 10,000 for pensioners Upper capital threshold for CTB/HB: increase from 16,000 to 50,000 for pensioners 14

16 Reform A The reforms would extend the scope to take pension saving as a lump sum rather than as an income They could mean some households are more dependent on means-tested benefits in later life, with a cost to the taxpayer But they could increase returns from saving in Personal Accounts 15

17 Reform A would extend the scope to take pension saving as a lump sum rather than as an income Estimated private pension wealth of people in England in 2002 aged between 50 and state pension age, 2006/7 earnings Current trivial commutation limit = 15,000 New limit modelled = 30,000

18 Reform A would increase the Government cost of pensioner means-tested benefits Illustrative projections of the cost of pensioner meanstested benefits, under the White Paper proposals and under Reform A, 2006/7 earnings

19 Reform A could increase returns from saving in Personal Accounts Estimated internal rate of return and risk groups Paul 25 year-old median-earning man Current limits 5.8% Reform A 5.9% Kate 40 year-old woman with modest caring and part-time work 5.2% 5.8% Jasmine 25 year-old woman with non-standard employment Paul (renter) 25 year-old median-earning man who rents in retirement 5.3% 1.6% 5.7% 2.9%

20 Reform B Trivial commutation limit: increase from 15,000 to 30,000 Capital disregards for PC/CTB/HB: increase from 6,000 to 30,000 for pensioners Upper capital threshold for CTB/HB: increase from 16,000 to 50,000 for pensioners 19

21 Reform B could further increase returns from saving in Personal Accounts Estimated internal rate of return and risk groups Paul 25 year-old median-earning man Current limits 5.8% Reform A 5.9% Reform B 5.9% Kate 40 year-old woman with modest caring and part-time work 5.2% 5.8% 7.1% Jasmine 25 year-old woman with non-standard employment 5.3% 5.7% 6.3% Paul (renter) 25 year-old median-earning man who rents in retirement 1.6% 2.9% 3.5%

22 Reform B could cost much more than Reform A Illustrative projections of the cost of pensioner meanstested benefits in 2012, under the White Paper proposals and under Reforms A and B, 2006/7 earnings

23 Reform C Trivial commutation and capital limits as Reform A plus A new drawdown product: Ten-year annuity bought with the proceeds of a trivial commutation lump sum which would not count in the calculation of entitlement to meanstested benefits 22

24 The drawdown product could result in a more even stream of income than spending a lump sum immediately Kate s total income (state and private pensions, capital drawn down and means-tested benefits), per week, 2006/7 earnings 579 Reform C: As Reform A but with new drawdown product Reform A (spends lump sum immediately): Trivial commutation limit: 30K Capital disregard: 10K Current policy

25 Reform C could further increase returns from saving in Personal Accounts Estimated internal rate of return and risk groups Paul 25 year-old median-earning man Current limits 5.8% Reform A 5.9% Reform C 5.9% Kate 40 year-old woman with modest caring and part-time work 5.2% 5.8% 7.7% Jasmine 25 year-old woman with non-standard employment 5.3% 5.7% 6.7% Paul (renter) 25 year-old median-earning man who rents in retirement 1.6% 2.9% 3.5%

26 Taking small pension pots as lump sums The reforms could improve returns from saving in Personal Accounts for some people at high or medium-risk: People with low earnings and broken working histories and no prior saving People who spend time self-employed People who rent accommodation in retirement They could also benefit some people at low-risk 25

27 Taking small pension pots as lump sums (2) The clearer the Government can be about the value of saving, the more likely Personal Accounts are to succeed Possible cost of 500m in 2012 (increasing to 1.4bn by 2050) A trade-off needs to be made 26