Pension Schemes Bill

Lord Hutton of Furness Excerpts

Tuesday 16th December 2014 Lords Chamber

[Lord Hutton of Furness (Lab)]

My Lords, I should like to draw the attention of the House to the interests I have declared in the register. I am an unremunerated non-executive director of Pension Quality Mark. I should also like to express my personal tribute to the noble Lord, Lord Jenkin of Roding, who in a few minutes will make his last contribution to our proceedings in this House. The noble Lord has made a truly extraordinary contribution to public and parliamentary life over a very long career. I, for one, am going to very much miss him in this House.

I strongly agree with what the Minister said in his opening remarks when he described these reforms as truly radical. They certainly are. I welcome the Government’s continued focus on looking at our pension system and ensuring, wherever possible, that people are thinking ahead to the needs they will have when they retire. This is a hugely important issue for our country. I regard it as perhaps the most important public policy challenge we face if one thinks about the nature and speed of demographic change in our country.

This problem has assumed even greater significance because of the general thrust and drift of public policy in the pensions space in the past 10 years or so. The burden of responsibility for providing secure retirement income is now rightly, in my view, steadily moving from the state to the individual. That is certainly the whole thrust behind the auto-enrolment reforms and the reforms to the state pension. For these policies to work, we have to be sure that people make adequate provision for their retirement. If they do not, the risk is that public finances will become unsustainable and that, once again, being old becomes the same thing as being poor. We need to avoid that outcome at every possible opportunity. Therefore, every reform to our pension savings system should pass one simple but important test: will it encourage more people to save more for their retirement?

There is much to be welcomed in the Bills before us today. None of us wants to be treated like an idiot, and it is right that we should therefore have more choice about what we do with our savings. I welcome that. However, it is right and proper that in this place we highlight some of the challenges that the Government’s reforms are going to create.

The first is that there is some tension between these two significant reforms—on the one hand, giving more freedom for savers in DC schemes and, simultaneously, providing for more risk-sharing in defined ambition schemes. Some people would say that these two reforms are not entirely compatible, and that is certainly the view of many in the industry. John Lawson, the head of pensions policy at Aviva and a much admired figure, went so far as to say recently that these reforms are completely incompatible with each other. On the one hand, encouraging more collective risk-sharing through collective defined contribution schemes sits oddly with the new freedoms at 55 to take out all the cash built up in conventional defined contribution schemes. One stresses the benefits of collective risk-pooling; the other, the right of the individual to make their own decisions about how to manage retirement income risks. In my mind, it begs the obvious question: what is the most important public policy objective that these reforms should prioritise? Is it freedom of choice or should it be income sufficiency in old age?

There is also the danger that we might begin to lose sight of something rather fundamental here. The purpose of a pension scheme is to provide secure retirement income for as long as the pensioner remains alive. It is not just about wealth accumulation and the instant gratification of converting your pension pot into a tidy cash sum. In my view, we should remain absolutely focused on the question of retirement income: how we can secure it and how, if possible, we can increase it.

One of the obvious risks in the Government’s approach to annuities reform is that there is a real possibility that more pensioners will start to run out of money in old age. Here, it is worth talking about the experience in Australia. It is true to say that auto-enrolment was heavily influenced by the Australian reforms, and successive Governments, including this one, have paid close attention to how this model has worked. The Chancellor of the Exchequer prayed in aid the Australian experience as providing the intellectual underpinning for his announcement on annuities reform. I am afraid to say that I am not entirely sure that he is on absolutely firm ground.

The recently published Murray report in Australia has recommended introducing compulsory deferred annuities that would pay out after the age of 85—going, I am sorry to say, in almost exactly the opposite direction to the one proposed by the Government here. This was recommended in Australia because it was found that a quarter of Australian pensioners had depleted their pension savings by the age of 70. There is a real warning sign here for us. That is why I strongly favour a hybrid approach—dare I say it, a third way—with greater freedoms to draw down pension savings on retirement, combined with a focus on the need to secure retirement income in later years. Allowing these new freedoms to be exercised at the age of 55 also poses another set of problems, particularly for employers.

The Organisation for Economic Co-operation and Development has also recently expressed similar concerns. It has pointed out—rightly, in my view—that pensioners in the United Kingdom are unlikely to achieve better incomes in retirement simply as a result of scrapping mandatory annuitisation. This, I think, gets us to the heart of the issue. We should remain focused on retirement income and on ensuring that every pensioner has adequate provision. At the end of the day, an annuity is merely an insurance against outliving your savings. This is a risk that the Government and individuals need to take very seriously. Partial annuitisation should at the very least be strongly encouraged as an integral part of planning for retirement. The danger today is that we appear to have created the sense that we have moved decisively against this kind of provision. That would be an enormous mistake.

As other noble Lords have said, there is the whole question of the so-called guidance guarantee which lies at the heart of the annuities reforms that are being set out in this legislation. I am yet to be persuaded that the guidance guarantee is sufficiently robust. It is not compulsory and what is being proposed is quite limited for such an important decision. Inertia will be a real problem. The FCA recently reported, for example, that 60% of people retiring with defined contribution schemes did not take advantage of the open market option of purchasing an annuity from a different provider, despite the fact that 80% of those individuals would have been better off. How confident can we be and how confident is the Minister that the guidance guarantee will be taken up properly?

The other great danger is that the benefits of the proposed collective defined contribution schemes are being seriously oversold. They are modelled largely on the experience of similar schemes in the Netherlands. It is important that we all understand that the Dutch pension landscape is not a land of milk and honey. I have no objection at all to these schemes being one option available to employers and employees, but I simply draw to your Lordships’ attention some problems. These schemes do not guarantee higher retirement incomes. They are no less vulnerable to unexpected lower investment returns than conventional defined contribution schemes. Just look at what has been happening in the Netherlands only very recently, with significant reductions being made to pension benefits. These schemes certainly expose younger savers to quota risks and the possibility that they will receive lower payouts as risks within these schemes are effectively shifted across different age cohorts.

I am not at all convinced that these schemes are all that progressive either. Lower earners who typically enjoy lower life expectancies effectively subsidise higher earners who tend to live longer. In the UK at present, those with lower life expectancies can receive higher retirement incomes through either enhanced or impaired annuities. This is not an option within CDC schemes. These schemes are inherently less transparent and certainly more complicated than other UK workplace pension schemes. My advice to the Minister and the Government is not to over-egg the pudding, although I suspect that it might be a little too late for that.

Looking at the provisions of the Bill relating to the defined ambition schemes, it is obvious that there is a very substantial regulatory risk for these schemes as the Bill grants enormous powers to the Secretary of State to legislate by way of statutory instrument as opposed to clearly setting out the parameters in the Bill. We do not yet know how these powers will be used and what form they will take. That creates obvious uncertainty for these putative schemes.

I shall conclude my remarks by saying one or two things about the Taxation of Pensions Bill. I am obviously aware that it is a money Bill and that we have no power to amend it, but I should like to raise with the Minister some concerns that I have about its provisions. I am pleased that the Government are removing some anomalies in the tax treatment of death benefits paid out of income draw down products and annuities, which will now be tax exempt if a scheme member dies before the age of 75. We all welcome that. It will, I hope, act as an incentive to save and should be supported. But the Government have made no changes to the taxation of a dependant’s pension scheme benefits which will still be taxable at the marginal rate of income tax. I am not sure that I understand the logic here. It seems perverse that a dependant’s scheme pension benefits should be treated adversely from a tax perspective compared with annuities and draw down products. This will surely encourage more members to transfer out of defined benefit schemes than would otherwise have been the case. Is this really the Government’s intention? It would be good for the House to know.

In fact the whole area of transfers from defined benefit to defined contribution and how they will be affected by these reforms is a moot point. It would be good to hear more from the Government about how they see developments in this space. Most informed commentators expect to see significant numbers transferring out of defined benefit schemes to defined contribution schemes to take advantage of the new freedoms on offer. There is a widespread concern that these DB to DC transfers, unless we are vigilant, are a potential mis-selling scandal waiting to happen. We really have to guard against that.

Much has been made of the fact that lump sum payments to nominated beneficiaries are going to be tax-free if the pension scheme member dies before reaching the age of 75. So far so good. I very strongly welcome the Chancellor’s focus on this issue. However, scheme administrators cannot nominate a different beneficiary from the person nominated by the scheme member himself or herself. That is clear from paragraph 3 of Schedule 2 to the Bill. I am particularly concerned that the effect of these changes could result in inheritance tax being payable on these lump sums—although not income tax because of the reforms in the Bill—on the basis that only death benefits paid out of a discretionary trust are exempt from inheritance tax. I hope that my fear is misplaced, but it would be very good to hear from the Minister on this point at some stage in our proceedings today.

I cannot fault the Government’s energy and commitment to pension reform, and I welcome it. It is impressive, particularly at this late stage of the Parliament, and both these Bills represent significant reform. The noble Lord, Lord German, who spoke earlier, said that this is a pension revolution. I think that it is, but, as any student of history knows, the problem with a revolution at the beginning is that you never can be quite sure where it is going to end. That, I think, remains the principal concern that I and many others have about the reforms set out in these Bills.

--- Later in debate ---

[Lord Newby]

My Lords, I think that the strong take-up of auto-enrolment suggests that people are actually a bit more long-sighted than they are sometimes given credit for. Young people in their 20s and early 30s who are thinking about their pension savings are looking at what kind of value for money they can get from doing that as opposed to putting their money into alternative forms of saving. So I am not sure that I altogether agree with the noble Baroness.

The noble Lord, Lord Hutton, said that the Government should strongly encourage partial annuitisation. We have always been clear that an annuity will remain the right choice for many at some point in their retirement because it can provide the security that they are looking for. He also asked about inheritance tax. I can say that the intention of the legislation is that the scheme administrator will retain some discretion over how death benefits are paid, ensuring that these benefits can remain outside the scope of inheritance tax.

[Lord Hutton of Furness]

I am enormously encouraged by the Minister’s response, but can he explain to me how they will do that?

[Lord Newby]

My Lords, I do not know, I am afraid, but I will write to the noble Lord as I am almost out of time. The House has rules that, as a Whip—although I know I am going to break them already—I can break only to a certain extent. I will write to the noble Lord in that respect. I might also write to him about the situation in Australia.

The noble Lord, Lord Freeman, asked whether the new flexibilities would put people at risk of poverty in the future. The basic principle here is that people must be trusted to make their own choices about how to use their savings to fund their retirement. We believe that the introduction of the new, simpler state pension in April 2016 will help minimise the impact on means-tested benefits as the full level of the new state pension will be above the level of the basic means test in personal credit, and we expect over 80% of those reaching state pension age in the mid-2030s to be receiving the full new state pension.

The noble Baroness, Lady Drake, took up the theme of the noble Lord, Lord Hutton, about the dangers of a revolution. She saw the dangers as being significantly more considerable, I think, than most noble Lords who spoke. Of course, some of the potential problems that she foresees are impossible to predict absolutely, but I did not recognise the gloomy landscape that she portrayed in a number of respects. She asked why we were still paying tax relief when people will spend all their money. Tax relief is designed to support and encourage people to save for their retirement.