George Osborne has been criticised by a respected economic think tank for making “uncertain behavioural assumptions” in pension reforms set out in his Budget this week.
In an analysis of the measures unveiled by the Chancellor on Wednesday, the Institute for Fiscal Studies (IFS) warned that allowing pensioners to draw down their pensions rather than being forced to buy an annuity will result in some blowing the money and relying solely on state help.
The Chancellor has defended the move, insisting that people should be trusted with their own cash, and pensions minister Steve Webb said yesterday it will be up to senior citizens whether they spend their retirement pot on a Lamborghini, the luxury Italian sport cars that sell for six-figure sums.
Mr Webb said: “If people do get a Lamborghini, and end up on the state pension, the state is much less concerned about that, and that is their choice.”
However, IFS director Paul Johnson said: “The liberalisation of pension rules is expected to lead to more tax revenue over the next few years. But that depends on rather uncertain behavioural assumptions and in the long run the Treasury expects the measure to reduce annual revenues in future years.”
The Budget package will see people given free financial advice about their pension pots and allowed to draw as much of their defined-contribution fund as they want. Instead of being hit with a punitive 55 per cent tax on sums they extract, they will pay normal rates.
But those who still want to purchase an annuity to fund their retirement will suffer, the IFS warned. Mr Johnson said: “There are some uncertainties about the effect of the policy. Most importantly, it will make annuities more expensive than they otherwise would have been.
“The market will become thinner and there will be greater levels of adverse selection.
“Only those expecting to live a long time will buy an annuity if they don’t have to.
“That’s not to say the policy is a bad one, but it is important to be clear about those effects.”
IFS deputy director Carl Emmerson suggested subsidies for pension schemes, such as the ability to take a tax-free lump sum, could be reviewed. “I think the Chancellor’s reform raises a bigger question – if we don’t have compulsory annuitisation, why do defined-contribution [DC] pensions get such generous tax treatment going forward?” he said. “The taxpayer is providing a subsidy there, and that subsidy is likely to get bigger if DC schemes are seen as being more generous in the future.”
The IFS also said the government risked weakening the UK’s public finances in the long term by using temporary rises in revenue to pay for permanent tax giveaways, and called for clarity on the substantial spending cuts needed in the next parliament.
The number of higher-rate taxpayers will increase from 4.7 million this year to 5.3m in 2015-16 – including around 350,000 in the top 45p bracket, the IFS predicted. The IFS estimated that 1.4 million more people were caught in the higher rate than under the plans inherited by the coalition government.
Mr Johnson said the Budget did not give enough detail about how the “very big spending cuts that are still in the pipeline” will be delivered. Cuts of 35.6 per cent would be required in unprotected departments if the NHS, schools and aid budgets remained ringfenced to 2018-19.
Gemma Tetlow of the IFS questioned the way Mr Osborne had funded his pension reforms and tax giveaways worth £4.9 billion a year by 2018-19.
“What was announced was a package of fairly permanent tax giveaways paid for by rather more unspecified spending cuts and a succession of measures which are temporary tax increases rather than permanent tax increases,” she said.
The think tank also criticised the decision to raise the income tax personal allowance to £10,500, saying a cut in national insurance contributions (NICs) would benefit more of those on lower incomes than the flagship Liberal Democrat measure.
David Phillips, of the IFS, said: “This tax cut is becoming even less well-targeted at those on low incomes because you need to earn £10,000 to gain at all from this latest increase.
“If the government did want to increase support for those on low incomes and low earnings, increasing the NICs threshold would be a better-targeted way of doing it.”
Mr Osborne said: “People who saved their whole lives, saved for a pension, these are responsible people.
“For many people, annuities have not been good value. I want people to be trusted to make decisions about their future.”