We weren’t the only ones celebrating the changes to pensions and investments recently announced in the Chancellor’s budget. Dr Ros Altmann - a former investment banker and Government adviser - has campaigned for a better deal for the consumer for years.
Watch our video blog, featuring Dr Altmann, Five Key Changes UK investors need to know about
Sensible Investing TV: Ros, you must be very pleased with the Budget on a number of levels. Are you surprised at how it went?
Ros Altmann: I’m absolutely delighted: not only did we get the changes to the ISA rules, but we also got these dramatic changes to the pension rules which will free up pensions and make them much more attractive to millions of people.
SITV: Let’s start with ISAs. What changes exactly were announced and what difference will they make to investors?
RA: First of all, the amount of money that people can put into an ISA each year has gone up from around £11,500 to £15,000 in one go. That is a big increase, but more importantly, the restrictions that had previously been placed on what you could do with the savings you put in an ISA have been pretty much swept away. Whether you want to save in cash or in stocks and shares or in peer-to-peer lending, you can do what you like, whereas previously you could only put half the annual allowance into cash, and you couldn’t switch to cash from stocks and shares. The effect of allowing people to put more money into a cash ISA is similar to an increase in interest rates and is a recognition of the fact that we’ve had such low rates for savers in the recent past.
SITV: ISAs have been quite a success story over the years. Presumably these changes will make them even more popular?
RA: The fascinating thing is that the amount of money that’s been put into ISAs in the last couple of years is more than the amount that has been put into pensions. That’s despite the fact that pensions were supposed to have the best tax relief. So clearly the public like the format of the ISA. There aren’t any real restrictions in terms of how you can allocate the money in an ISA, and you’re free to do what you wish with the money you take out without being taxed. The public like that and the fact that people can put more now each year into an ISA is likely to mean that more money is going to go into ISAs - although some of that money may find its way into pensions now too.
SITV: There was also help for less well-off investors, wasn’t there?
RA: Yes. Until now, for savers with low incomes, the first £2,000 or so of their savings income would only be taxed at a 10% rate. What the Chancellor has decided is that smaller savers won’t pay any tax on the first £5,000 of their savings income. So as well as helping the better-off saver, this is actually a concrete measure to help savers who don’t have a lot of money put by.
SITV: Of course the biggest changes were to pensions. For a start, they’re going to be much more flexible.
That’s right. The buzzword for these changes is flexibility. Until now, we have had the most inflexible pensions system in the world. There is no other country, for example, that automatically requires most people to buy an annuity when they reach retirement. Those inflexibilities and restrictions are being swept away. That means a whole new world for pensions. This is a real game changer.
SITV: Specifically, how significant are the changes with regards to annuities?
RA: What the Chancellor has done is to remove the restriction which led most people down the path of buying an annuity with their pension savings at retirement. Unless they had very large pension pots, which might allow them to go into what’s called Income Drawdown, the only way they could really get an income from their pension fund apart from taking tax-free cash was to buy an annuity. Once they’d taken their tax-free cash there was a requirement that within six months they secured an income from the rest of the fund, which basically drove people to buy an annuity.
The annuity is an insurance contract which promises to pay you an income for the rest of your life in exchange for your pension savings. But once you’ve bought that product you can never change it - you’re stuck with it - and annuities have become much worse value in recent years, especially after the dramatic drop in interest rates. From now on, if you have a pension fund worth less than total value of £30,000, you can take that as cash, but you’re taxed on anything other than the tax-free cash. You can cash in up to three pension funds worth under £10,000 each, whereas until now you could only take cash out of two funds worth up to £2,000 each. Then, from April 2015, there won’t be a restriction even on that and you’ll be allowed to take as much as you like out of your defined-contribution pension savings and spend it as you wish - subject to your marginal rate of tax.
This is an enormous change. Until now, if you like, the nanny state was saying, we don’t trust you with your money. Even though you’ve been responsible enough to put money aside for your retirement, we’re going to tell you what you’re allowed to do and how much money you’re allowed to take from your pension fund.
SITV: The Pensions Minister said that some might even want to spend part of their pension pot on a Lamborghini. Is there a danger that people may be tempted to spend more than they can afford and then be reliant on state help?
RA: There is certainly a risk that some people will see this money is available to them and suddenly decide to spend it. But I don’t believe that will be the majority. I think if people have been responsible to set money aside for retirement, they would normally be the kind of people who won’t just blow the lot on frivolities. If they want to pay back their mortgage, or if they want to help their grandchildren buy a house - it is, after all, their money - are they not entitled to spend it?
What the Chancellor has done is merely give the same freedom and flexibilities to everybody as already exist for the very wealthiest people in society. For those with the biggest pensions, the rules already allow them to do what they want with their pension fund. Is it really right to say to ordinary people, we trust those guys not to do anything silly but we don’t trust you?
Also, under reforms due to come into effect in 2016, there’ll be a flat-rate state pension. That itelf vastly reduces the likelihood that people will end up on means-tested benefits in retirement. It’s fine if people have spent all their money. They’ll get around £20 a day, if that’s all they want. They’ll know the deal.
SITV: Shortly after the Budget, the Government made an announcement on charges for automatic-enrolment pension schemes.
RA: Yes, the Pensions Minister has said there will be a cap on the charges pension firms can levy on auto-enrolment default funds. Until now there has been no control on the level of fees that could be charged for schemes which workers were being automatically enrolled into. There was - and is - a significant concern that as you get more and more smaller employers setting up pension schemes there’ll be a big capacity crunch in the industry. There was then a danger that charges would increase quite significantly to reflect the extra demand. The biggest danger here is the principal agent problem, because it is the employer that chooses the pension scheme but it is the worker that pays the charges. And of course the higher the fee, the lower the pension the member will ultimately get.
The Government is absolutely right, in my view, not to be swayed by the fact that, up until now, new auto-enrolment schemes have actually had quite low charges. The average charge for a new auto-enrolment scheme is only about 0.5%, whereas the charge cap is 0.75%. But the danger is that those early auto-enrolment schemes belong to big companies, and big firms have more muscle to negotiate better fees, understand the issues of pensions and have HR departments who will look after the interests of the worker. But in the next couple of years you’re going to have lots of employers having to set up pension schemes who don’t know the first thing about pensions, so their workers need protection.
SITV: What did the Pensions Minister announce regarding transparency?
RA: The cap on charges only applies to what’s called the Annual Management Charge, which is basically the fund management fee for managing the pension scheme. But there are lots of other charges on pension funds. Legal fees, administration costs and transaction charges can add significant extra amounts to the overall charges that are taken out of workers’ pension schemes each year. So the Government has decided that as well as having a 0.75% Annual Management Charge fee cap from April 2015, by April 2017 all the extra charges that are not included in the AMC will have to be fully disclosed. The implication is that the Government may well decide then to put a cap on a wider range of charges. The danger otherwise is that although there’s a cap on the AMC, providers will merely add extra costs in a different way so that the total expenses will still be much higher than the capped charge and members will still lose out.
SITV: But don’t we need just a single charge - one simple figure that people understand?
RA: My view is that we should have one charge that includes all the management expenses. I wouldn’t go as far as including transaction costs, as long as they’re disclosed, because you don’t want to deter your fund manager from moving the assets around in a way he or she thinks is necessary. But otherwise there should be one overall charge for managing and administering the fund. Unfortunately the NEST scheme has a two-tier charge structure, which the Government will still allow, and that makes it much more difficult to compare schemes with each other. NEST has a 1.8% upfront initial fees, then a 0.3% annual management charge ongoing. Now if you’re in this scheme and contributing to NEST for, say, ten years, that will bring the annual management and overall fee level down to well below the 0.75% cap. But if you’re only in the scheme for a couple of years you may end up actually being over the cap.
You can keep up with Ros and her campaign for a better, fairer pensions system via her website, RosAltmann.com