It's not often these days that the UK Chancellor of the Exchequer comes out with a bombshell in his Budget speech that has a significant impact on the markets, but such was the case on Wednesday this week when George Osborne effectively abolished the personal savings and group defined contributions benefits system.
The old and now soon-to-be-abolished rules on pensions have long been a matter of contention, and over the decades various governments had tinkered with the rules . However, the requirement remained that, by the time you hit the age of 75, you were forced to give up your hard-saved money to an annuity provider, in return for a guaranteed annual income. And, once you died, that was it. Nothing was left to pass on to your heirs.
This week Osborne abolished the requirement to buy an annuity, and abolished any lock-up. At a stroke, your pension pot had become a tax-efficient savings pot. As supply-side reforms go, this is probably one of the most radical and courageous that we have seen from any UK government since the war, or even since the system was introduced in 1921.
The ostensible reason given by Osborne is one that coincides nicely with "traditional Tory values". He claimed that the current rules surrounding pensions were "a manifestation of a patronising view that pensioners cannot be trusted with their own pension pots". The new laws (which are so radical that a separate act of parliament will be required to implement them) will give people complete freedom with the money that they have saved.
Of course, just because a view is patronising does not mean that it is false. No-one, least of all the Labour opposition, wants to shout from the rooftops that most people, given the chance, would blow the lot on smart TVs, holidays and new shoes. It is also my suspicion that this will not be the case. The truth is, we just don't know. But my hunch is that most people will choose not to take all of their money as cash. They will take the tax-free 25% that they are permitted to take, and leave the other 75% in yet-to-be-invented savings schemes.
In that sense, the frantic downgrading by the market of the leading life assurers (Legal & General, for example, was off 8.37% by Wednesday night) is an overreaction. If people swap one savings scheme (forced annuities) for another (say, sustained slow drawdown) the annuity providers are unlikely to suffer except at the margin.
But Chancellor Osborne probably has other motives, ones that are less tied to high-minded points of political principle. The first – it looks like a blatant attempt to re-engage with older voters (who are more likely than younger people to be savers and are more likely to vote) from potential defection to the UK Independence Party – need not concern us here. But the second – that this is a sneaky attempt to boost tax revenues in the short term – is of considerable interest from a macro-economic viewpoint.
Projected tax impact of the changes according to UK Treasury figures
There must be at least a part of the Osborne psyche that hopes the change DOES lead to a mass expenditure splurge, because it would "help" the UK economy on two fronts. First, the expenditure itself would serve to increase economic activity, although there is always the danger that the multiplier effect would be low (holidays abroad, imported TVs and shoes). But in the past five years the greatest boost to consumer expenditure has not been Quantitative Easing – most of that has gone into the latest asset bubbles – but refunds for missold payment protection insurance, with at least a part of this spent on cars – now a UK manufacturing stronghold. That, as it were, supports the argument that there is a "spend today" group quite distinct from the "save for a rainy day" group.
Secondly, the change in the rules means that anyone who decides to draw down all of their pension pot (the average size of which is woefully small – less than half way to six figures) will be liable to tax at a marginal rate for everything over the 25% that can be taken out tax free.
This, the Treasury calculates, will provide a strong short-term boost to taxation revenues. It is, therefore, from Osborne's point of view, a win-win. The measure boosts both economic activity and government revenues. What could possibly go wrong?
As is always the case, of something looks too good to be true, it usually is. As was the case with the mass of remortgaging in the early 2000s, all that the Chancellor's measure does is borrow from the future. If (as he hopes) a large number of people draw down their entire pension pot, and spend it, that is tax revenue the government will not get in the future and consumer expenditure that is not a real increase, but one brought forward from a later date.