Are insurers looking after No 1 over the savings gap?

Published on Friday 4 July 2008 21:48

AS OIL prices reach historic highs, the urban myth that the petrol companies have deliberately inhibited the production of alternative motor engines that don't use their precious commodity has resurfaced.

Whatever the facts, this type of theory can often sound plausible – after all you could understand an industry acting to protect its own. But forgive? Perhaps not.

The pension and savings industry does not face the same sort of cataclysmic outcomes as the global fuel industry, but it is certainly facing a crisis. Day after day, we hear from the industry, government and commentators that the UK is facing a massive savings gap because we're just not saving enough.

However, I would argue that this crisis is actually being exacerbated by the pensions industry itself. Sadly, there is enough evidence to suggest that this could be the industry seeking to protect its own – by failing to develop and update its systems, it is robbing customers of the ability to obtain flexibility in their savings, pay less tax or obtain more tax relief.

The industry was presented with a huge opportunity in 2006, when a new set of pension rules were introduced with the aim of simplifying pension investment. One of the most profound changes involved lifting the lid on the maximum annual contribution which could be made into a pension. Effectively, investors are now able to contribute their entire annual salary to a pension.

A consequence of this – possibly unforeseen – is that people no longer have to religiously invest in a pension each year for fear of missing out on their annual allowance. Instead, regular long-term savings can now be stored up in an alternative product (such as an individual savings account, a direct open-ended investment company or even a friendly society tax exempt savings plan) and strategically switched to a pension at a time of the client's choosing.

This flexibility obviously has some benefits to investors who are reluctant to lock their pension savings away until they retire – a common objection to pensions – but it also brings real financial benefits. For example, a basic rate taxpayer could decide to store up their contributions in an Isa and receive tax-free growth on this investment – just like a pension.

When eventually they start to pay higher rate tax, they could switch this accumulated Isa investment into a pension.

For a higher-rate taxpayer, this would mean either a substantially reduced tax bill or a substantially higher investment (through higher tax relief) in the pension pot. Of course people who don't become higher-rate taxpayers would still have the flexibility of switching into a pension at a later date and be no worse off.

The only argument against this is that the majority of such investors are members of employer pension schemes and, unfortunately, employer contributions do not benefit from the same flexibility. However, there is a simple solution; amend group pension contracts so that employee contributions can optionally go into an Isa first, while top-ups and employer contributions go into a linked pension contract.

It's clear that using a pension strategically in this way rather than slavishly investing every month no matter what level of tax is paid can provide huge financial benefits and additional flexibility.

So why hasn't it caught on?

The fact of the matter is that change will not come unless the product providers lead the way. Is this lethargy simply because too many of the big players in the industry have a heavy investment in group pensions systems and can't face the costs and additional complications of adding an Isa?

Are the vested interests of the pensions industry standing in the way of a development which could improve the lot of long-term savers at a time when they need it most?

I hope I'm wrong, but I worry that this is another unforgivable example of an industry protecting its own.

• Neil Lovatt is sales and marketing director at Scottish Friendly