The pensions industry’s cultural attachment to opacity, and its talent to complicate, has led to it becoming widely distrusted. This deters engagement. In addition, many people value ready access to savings above the up-front incentive of tax relief on pension contributions: pensions products are just too inflexible. Consequently, as confirmed by savings statistics and surveys, many people prefer to contribute to an ISA, which means that they miss out on tax relief.
The government has responded with the Lifetime ISA, to be introduced in April 2017, a move widely welcomed by the under 40s, in particular. Savings of up to £4,000 per year, made with post-tax income, will be topped up by a 25 per cent bonus, paid irrespective of tax-paying status. The Lifetime ISA’s pending popularity is reiterated by several major industry providers, including Standard Life and Hargreaves Lansdown, which have been quick to commit to marketing it. However, others within the pensions industry have been less enthusiastic, not least because the Lifetime ISA will provide competition in the private pensions arena.
Meanwhile, in respect of occupational pension provision, the government is pursuing its auto-enrolment (AE) agenda. Millions of workers are being defaulted into workplace schemes that requires contributions from both them and their employers. However, a concern has been expressed that some workers may opt out, preferring instead to contribute to the Lifetime ISA (and lacking the disposable incomes to contribute to both). They would then lose their employers’ contributions under AE. To remove this risk, the Workplace ISA should be introduced to complement the Lifetime ISA.
Key features of the Workplace ISA
The Workplace ISA, included within the AE legislation, would be specifically to accommodate employer contributions made under AE, taxed at the employee’s marginal rate. However, these would be accompanied by the same 25 per cent Treasury bonus as the Lifetime ISA (economically equivalent to basic rate tax relief on pensions’ contributions). Withdrawals from the Workplace ISA should not be permitted until the age of 60, but thereafter they would be tax-free. In parallel, auto-enrolled employee contributions, made from post-tax income, may be paid directly into the employee’s Lifetime ISA, subject to the same rules already planned for general contributions to the Lifetime ISA. Thus they would be eligible for a 25 per cent Treasury bonus, and would be subject to the same tax, withdrawal and penalty rules as other Lifetime ISA savings. As a simplification measure, the Workplace ISA could be housed within the Lifetime ISA, leaving the individual with a single retirement savings vehicle. In addition, Workplace ISA assets should enjoy the same Inheritance Tax treatment as today’s pension pots, and should be excluded for means testing purposes, as per today’s pension assets.
ISAs as part of auto-enrolment: to discourage opt-outs
Including the Lifetime and Workplace ISAs within the AE framework would enable employees to choose where AE-related contributions would be accumulated. The choice would be between a Lifetime ISA (for employee contributions), a Workplace ISA (for employer contributions) and the employer’s own occupational pension scheme (for either, or both, contributions). Auto-enrolled Lifetime ISA contributions would provide employees with the benefit of flexible access to their own AE-inspired contributions, which would likely discourage them from opting out of auto-enrolment. This is important, given that within the next three years employees’ statutory minimum contributions are set to quintuple, from 0.8 per cent to 4 per cent of band earnings. Being in control is closely allied to being motivated (perhaps, in this case, to save more), and therefore engaged.
Affording the bonuses
The Lifetime and Workplace ISAs should share an annual cap on contributions of £10,000, say, subject to Treasury cost modelling in respect of bonuses. The £14bn annual spend on NICs relief on employer contributions to pensions should be redeployed to help pay for this. Today, NICs relief goes to shareholders rather than savers, so employees are oblivious of it. Consequently, as an incentive to encourage individuals to engage with saving, it is an ineffective use of scarce Treasury resource. Far better for it to be paid directly into employees’ ISAs: thus visible, it would be more appreciated by the individual.
The employers’ perspective
Employers are integral to auto-enrolment’s success, and they are likely to support the Workplace ISA. They have long complained that their pension contributions are undervalued by employees, and therefore represent poor value for shareholders. The Workplace ISA, by residing within employees’ Lifetime ISA, would be more personal to the individual.
And remember the self-employed
More than half of the working-age population is ineligible for AE, notably the 4.6 million self-employed, but also 23 per cent of employees. The DWP should sponsor a Workplace ISA for them, perhaps delivered through the National Employment Savings Trust (NEST), the workplace pension set up by the government.
The Workplace ISA: in the national interest
The UK has one of the lowest net household savings ratios among OECD nations. The pensions savings model is broken. More than ever, we need to encourage more people to save more, helping to close the savings gap, to the benefit of the individual, UK plc and the industry. The Lifetime and Workplace ISAs, operating together, would help many people achieve one simple goal at the point of retirement: to be a debt-free home owner (and ideally free of any consumer debt). Thereafter, they could perhaps downsize to top-up their retirement income, and perhaps finance long-term care. Ideally, the Workplace ISA will be announced in 2017, after a thorough assessment of the public’s response to the Lifetime ISA, perhaps for 2018 implementation. It would, of course, compete with today’s occupational pensions savings schemes. Michael Johnson is a Research Fellow at the Centre for Policy Studies