Labour’s pension choice

How should Labour respond to the annuities revolution?

Not by rejecting it. So the right first step is already taken.  The change is a surprise with risks.  But it’s a one directional move.  The old rules cannot be resurrected.  The pension world has changed and will change more, and annuities must change too.

Labour can acknowledge that it also considered annuity reform when in office, accepting that the pressure to change was already there.  But Labour need not be too shy about why it held back from far-reaching changes.  Many of the good reasons for doing so have now suddenly sprung into the foreground again, following Osborne’s announcement.

Opposing the change would have tied the party to unpopular compulsion. But to accept the Chancellor’s initiative in its entirety, would also be a mistake.  The ‘three tests’ are a start.  But we can go further.  There are policy initiatives here for the taking.

It’s time again to consider the risks inherent in the Osborne move, and make solid proposals about how they can be minimised.

The old annuity rules rested on a tax deal.  The state gave tax incentives to save for a pension, and tax protection for the fund – in return for individuals securing some additional income in retirement and not therefore relying on the state for additional support.  The Osborne reform breaks the deal.  And opens the way to increased consumer risk, moral hazard and to potential tax avoidance.

One mid-point response could be to look again at the linkage between annuities and the tax system.

Annuities must and will remain the product of choice for many moving into retirement.  The core attractions remain and trump most alternatives: security of income and insurance against outliving savings.

Yes, the market can be better.  The products can be more flexible and the encouragement to shop around and take the advantages of competition can be strengthened.

But now there are new risks to be avoided.  Risk 1 is the ‘Lamborghini option’.  The funds will be spent or will run out too early.  Coalition ministers say they are relaxed about this.  They should not be.  This is a potential problem both for the retirees involved and for the taxpayer.  The risk can be minimised by leaving in place some tax incentives, and so rebuilding part of the former tax deal.  Here are two ideas for Labour to consider.

Introduce an annuity income tax allowance.  This could be an additional personal tax allowance that sits on top of the basic income tax allowance.  For instance the £10,500 personal allowance could be supplemented by £2,500 for income drawn from a lifelong fund, i.e. an annuity.  This additional allowance adds a strong incentive to direct pension pots to providing income throughout retirement.  The choice to do otherwise remains.  But now there’s an additional incentive to stick to the deal. Reducing all tax allowances on pension contributions to the basic rate will fund the change, and is redistributive.

Protect social care funds from tax.  There is now an increased opportunity to build a link between a conventional annuity and a source of cash to fund long-term care.  The two reforms sit alongside each other.  One option, now that the pension pots are available, is to assign some, or all, of the fund to meeting care costs at some point in the future, now that more people will know that the first £72,000 has to be met from personal means.  It won’t be an easy choice, but some will wish to make it.  An additional tax incentive could help.  And if unused, any remaining funds in the account should be free from income of inheritance taxes.  That way, the wish to pass on a legacy can be protected and not completely compromised by opting to make provision for care.

Risk 2 is a renewed surge in mis-selling.  This looks like a big risk in the Osborne gamble.  The ‘guidance guarantee’ promised looks hardly credible, given the tight timeframe, the need to meet 500,000 annual decisions, and the paltry £20 million fund to scale up a robust offer.

Labour must press for more action here.  Choice is fine, but retirees are not anxious to embrace choice without information and choice loaded with avoidable risk.  This is about income in retirement and almost everybody still wants some certainty about that.  So the Coalition needs to be pressed to get serious about this.

Annuities will remain a big part of the solution to securing adequate income in retirement, even if the range of products now expands both by variety and flexibility.  Labour can embrace the agenda of choice , but can now ensure that it can come without too heavy a price of risk or moral hazard.