Fidelity Savings Manifesto


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Four proposals to help rebuild a savings culture in the UK

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Fidelity Savings Manifesto

  1. 1. This document is for investment professionals only, and should not be relied upon by private investors FEBRUARY 2010 Improving incentives for medium and long-term savings A thought paper by Fidelity International
  2. 2. IMPROVING INCENTIVES FOR MEDIUM AND LONG-TERM SAVINGS SUMMARY PROPOSALS UK household saving is inadequate. This is so when considered against both historic levels and the level required to support increased life expectancy in retirement. At the same time, broad understanding of tax incentives is poor and the savings industry has developed over-complex product structures in response to years of adjustments to the savings taxation landscape. Our proposals are based around a desire to support an increase in overall levels of saving from all sections of the population with the capacity to save, to encourage more persistent saving and to promote a whole-of-life approach to saving – which we believe can all be achieved through better deployment of current Exchequer support for medium and long-term savings and simpler, more understandable incentives. Importantly, the current proposals for auto-enrolment into occupational pension schemes will still not provide the broad level of savings required for a comfortable retirement. Without an increase in the general level of saving, many will reach retirement age disappointed. We propose: • building on the success of ISAs through the provision of an annual bonus paid on investment and at each subsequent anniversary • introducing an annual cap on pension contributions for all (e.g. £50,000) as a fairer and more transparent mechanism to replace recent taper proposals for incomes of £150,000+ • encouraging whole-of-life savings by incentivising transfers from ISA savings to pensions • promoting flexibility in retirement by ending compulsory annuitisation beyond an index-linked threshold BACKGROUND – THE SAVINGS GAP British people are not saving enough. In the absence of sufficient savings, people face hardship in retirement. There are furthermore specific life events for which savings may be desirable (e.g. education, long-term care). As the concept of a ‘job for life’ disappears, it is also important that people have a ‘rainy day’ pot to cover gaps in their working life. Based on current demographics and ongoing pressure on the public finances, it appears unlikely that the State will be able to provide adequately for most people’s retirement or other periods of need. One way to increase levels of saving is compulsion, but there remains significant resistance to obligatory savings. Individuals might also be encouraged to save more through better education. This is desirable and should run in parallel with any system of incentives. Likewise, better guidance on the level of income that needs to be saved and the total level of savings required to provide a meaningful benefit should be encouraged. The State currently provides encouragement to save through ‘tax breaks’ and this kind of incentive is likely to be a key element of any future plan to reduce the savings gap. Monetary incentives are, therefore, the main focus of our proposals. 2
  3. 3. ENCOURAGING NEW SAVINGS Monetary incentives have long underpinned the pensions industry and, more recently, shorter-term savings via individual savings accounts (ISAs). There remains some uncertainty about the degree to which these incentives encourage new saving or simply lead to the re-allocation of existing savings, especially among higher-earners. Our proposals are, therefore, designed to encourage new saving by groups who are currently not saving adequately while minimising any associated disincentive for existing savers. Hence we explore in this paper ways to widen the pool of those saving via ISAs. It is our view that simply increasing ISA limits will have only a limited effect on encouraging new saving whereas efforts should be focussed on increasing the participation rate. Current Exchequer support differentiates between short to medium-term (ISA) savings and long-term (pension) savings. The principal distinction is the way in which pension savings are locked down until a pre-determined retirement age while ISA savings are fully accessible. In compensation for restricted access, greater incentives are provided for pension savings, including up-front tax-relief on contributions. The current support provided by the Exchequer is skewed heavily towards pension savings, as illustrated below: SAVINGS VEHICLE TAX ESTIMATED COST Approved Pensions Schemes Income tax £19.7 billion Individual Savings Accounts (ISAs) Income tax £1.6 billion Employment related share savings Income tax £0.4 billion Source: HMRC; Table 1.5 Estimated costs of the principal tax expenditure and structural reliefs (December 2009) Although greater incentives are currently applied to pension savings, the requirement to forgo access to saved capital acts as a disincentive, particularly to younger savers. The pension incentive is also disproportionately enjoyed by high earners. The tax incentives for ISA saving are relatively insignificant, especially for basic rate tax-payers. This is the group most likely to be motivated by tax incentives to create new savings and most at risk of falling back on the state in retirement. THE VEIL OF IGNORANCE Although tax incentives are currently the principal means by which Government encourages saving, research suggests that tax is poorly understood. Recent independent research carried out for Fidelity International reached inter alia the following conclusions: • Almost one in five (18%) UK taxpayers do not know their income tax band • A quarter of people earning more than £50,000 think they pay the basic rate of tax • Half of the population does not know anything about forthcoming changes to tax legislation • Those earning under £30,000 a year are twice as likely as higher earners not to know anything about savings and investments • Just 10% of people with the option to do so pay the full amount into their company pension scheme • Of those who had the option to join a company pension scheme but hadn’t done so, nearly a fifth did not know why they had not • Of those who do contribute to their company pension scheme, 22% still do not know the tax advantages that their workplace pension offers Source: Fidelity’s Great British Tax Conundrum: Research conducted by Opinium Research, online survey of 2,000 people (nationally representative) between the 24th to 28th September 09. FEBRUARY 2010 3
  4. 4. IMPROVING INCENTIVES FOR MEDIUM AND LONG-TERM SAVINGS Proposals 1. INCENTIVISING ISA CONTRIBUTIONS Proposal: ISAs to receive a small cash bonus on entry, with subsequent payments at the same rate on each anniversary, for the life of the account 1.1 ISA savings are flexible but are perceived to offer a limited incentive to save, especially for basic-rate taxpayers. They are generally accessible, can provide a buffer against unforeseen eventualities (e.g. redundancy) and, if not needed during working life, can be used in retirement. 1.2 ISAs are the mainstay of short-medium term savings, especially since the recent increase in the annual allowance to £10,200 (£20,400 for couples). A strong case can be made for a greater proportion of the overall incentive budget to be used to encourage this form of ‘unlocked’saving. However, there must be a demonstrable incentive to save in this way. 1.3 Currently, the investment return from an ISA is tax-free at a cost to the Exchequer of £1.6 billion (excluding any forgone CGT). The incentive arises predominantly from interest-bearing investments. We believe that investors should see adequate and equal incentive for equity as well as interest-bearing investments. 1.4 Based on current annual investment levels of around £37.5bn*, some form of up-front incentive should be considered. Enhancement in line with basic-rate pension contribution relief (20%) would cost too much but a smaller incentive may be affordable. We propose that each contribution to an ISA should receive a small cash enhancement on entry, repeated at the same percentage of the current value on every subsequent anniversary in perpetuity. There are five principal advantages to incentivising unlocked savings in this way: • simplicity – savers would readily understand the concept of a cash enhancement • persistency – the payment of an annual incentive would discourage ‘raids’on ISA savings • affordability – the cost to Government would be spread over many years • fairness – the payment of an annual bonus would apply equally to equity and interest-bearing investments, going some way to restoring the status of ISAs following the abolition of the dividend tax credit • youth appeal – it will encourage new savings from groups e.g. young savers who traditionally shy away from saving. *Source: HMRC, Table 9.4 Individual savings accounts (July 2009) 4
  5. 5. 2. INTRODUCING AN ANNUAL LIMIT ON PENSION CONTRIBUTIONS Proposal: An annual cap on pension contributions (say £50,000), which would attract tax relief at a saver’s highest rate, to replace the recently announced tapering of pension relief for incomes above £150,000 2.1 We believe that the latest changes to pensions tax relief announced in the 2009 Budget, including tapering relief for incomes of £150,000 reducing to 20% at £180,000, are poorly developed, too regressive in nature and damaging to overall levels of pension saving. They erode predictability of Government support for pensions and make the administration and provision of benefits for these earners excessively complicated and the benefits hard to quantify and understand. 2.2 In our opinion a better way of achieving the same policy goals (reducing the Exchequer cost of tax relief and rebalancing the proportion of relief enjoyed by higher rate taxpayers relative to lower earners) would be to set an annual cap on contributions (say £50,000) which would attract tax relief at a saver’s highest marginal rate. As well as achieving policy goals, this would maintain the simplicity of the current system by offering full marginal tax relief on pension contributions. The level of the annual cap could be varied to achieve different policy goals (including paying for the ISA incentive set out above). 3. LINKING ISA SAVINGS TO PENSION SAVINGS Proposal: To permit transfers from ISAs to pensions in excess of the annual cap on pension contributions 3.1 There is considerable merit in promoting an easy to understand, whole-of-life approach to savings and we believe that Government should formally encourage the transfer of ISA savings into pension savings. In effect, investors would be given a financial incentive to transfer their accumulated ‘unlocked’ savings into a ‘locked’ pension pot. At that time, they would receive the same monetary incentive available to non-transfer pension contributions. The pot would then remain locked until retirement and become taxable in payment. 3.2 These ISA transfers should be permitted notwithstanding any annual limits on pension contributions (i.e. ISA transfers would be permitted in excess of the [£50,000] annual cap on pension contributions). This would encourage the build-up of savings in the earlier years of working life in anticipation of being able to make enhanced pension contributions closer to retirement. In earlier years, savers would retain flexibility over access to their ISAs until they were ready to lock their savings down in a pension. 3.3 There is a case for considering a similar incentivised transfer from Child Trust Funds to ISAs in addition to any ongoing ISA contribution limit. FEBRUARY 2010 5
  6. 6. IMPROVING INCENTIVES FOR MEDIUM AND LONG-TERM SAVINGS 4. FLEXIBILITY IN RETIREMENT Proposal: To update annuity rules to introduce an index-linked threshold above which annuitisation of pension pots is no longer compulsory Proposal: To update trivial commutation rules to allow cash withdrawals of small pension funds Proposal: To allow early access to pension savings for certain defined life events 4.1 We believe that the holistic and incentivised approach to saving for retirement should continue in retirement. Incentives given to assist or promote saving (accumulation) are easily undermined if it is perceived that the retirement phase (decumulation) is penal or restrictive. 4.2 Compulsory annuitisation removes individual choice and responsibility. Having asked people to take individual responsibility to save for retirement, it is then unfair to exert too much control over the way in which benefits can be taken. We believe that the highly restrictive annuity rules should be updated. This will go some way to restoring the attractiveness of pension saving. 4.3 It has always been argued officially that annuitisation was a not a topic for discussion politically as only well-off people benefited. This will no longer be true with the advent of personal accounts. Although the build-up of amounts in personal accounts will take some time, altering the annuity rules will increase the attractiveness of pensions saving immediately. 4.4 Some control is inevitably needed to prevent those with small pension pots from exhausting their savings and falling back on the State but the regime should be as flexible as possible. This could be achieved by introducing an index-linked threshold level up to which pension pots must be annuitised. For pension savings above this level, there should be complete flexibility to annuitise or draw down throughout life as the individual chooses. 4.5 This would also mitigate the perceived unfairness that pension pots which have been annuitised cannot be passed on at death. There is anecdotal evidence that people who are aware of this kind of restriction on annuities sometimes choose to put their savings elsewhere (for example, into an ISA). 4.6 We also believe that the trivial commutation rules should be reviewed and updated so that those who have saved during their working lives but have not amassed a pension pot which is worth annuitising can draw the entire pot as a cash lump sum. These trivial commutation rules should be applied on a consistent basis to occupational and personal pension schemes. 4.7 We also believe that there is a case for allowing early access to pension pots for defined events e.g. long-term unemployment or serious illness. This list of events would need to be carefully circumscribed to avoid this option being seen as another easy way to obtain credit. One option for consideration would be to limit any withdrawals to the value of the accrued tax-free lump sum. 6
  7. 7. 5. OTHER MEASURES Proposal: To roll out auto-enrolment without delay Proposal: To review the interaction of means-tested benefits with medium and long-term savings 5.1 We welcome the policy goal to introduce auto-enrolment into employer pension schemes and encourage Government to roll this out without delay. This harnesses employee inertia and should lead to almost complete coverage for employees in their employer schemes (subject to the individual’s right to opt out). There are also additional flanking measures that can be envisaged, e.g. automatic contribution increases as salaries rise, which will help individuals progress beyond the basic level of saving that the auto enrolment regulations require. 5.2 Beyond this, Government needs to review the interaction of means-tested benefits with medium and long-term savings. If individuals take the view they are better off not saving and relying on means-tested benefits to top up their state pension, this could lead to very significant numbers of people exercising their right to opt out of auto-enrolment. This might threaten the viability of the entire project. CONCLUSION The current system does not encourage a whole-of-life approach to wealth accumulation. Nearly all today’s support is given to pension planning, which is inaccessible until retirement. For an average saver, this represents a serious disincentive. Savings are locked away and unavailable as a buffer against unpredictable but probable financial needs. It is recognised that the primary focus of incentives must be on longer-term retirement provision, but the current structure does little to incentivise a more gradual or transitional approach to retirement, which would allow savers to balance the possible need to access money with a commitment to their eventual retirement. By contrast, we believe that our straightforward and easy to understand proposals would, in combination, encourage: • early adoption of a whole of life savings habit • the reassurance that savings can be accessed if required • the transfer of savings from unlocked to locked retirement savings • the ability of the government of the day to flex future incentive levels to encourage either greater locked or unlocked box saving By doing so they would achieve the principal goal of increasing the level and persistency of household savings, fairly and at an affordable cost. FOR FURTHER INFORMATION, PLEASE CONTACT: Sam Slator Anne Read Fidelity International Fidelity International 01737 837 847 020 7961 4409 07841 783882 07850 549839 Press Office Address: Fidelity International, Kingswood Place, Millfield Lane, Lower Kingswood, Tadworth, Surrey, KT20 6RP FEBRUARY 2010 7
  8. 8. FIL Limited (“FIL”) and its subsidiary companies serve the major markets of the world by providing investment products and services to individuals and institutional investors outside the US. For more information you can visit Any opinions expressed are made at the time of writing and can be subject to change without notification. ICC002/31528/PDF/SS0926/na