So when are pensions price-elastic?
Of course, low prices are a good idea. Especially when it comes to pensions, and we are talking about helping someone to eke out their life savings over ever increasing number of years of retirement. So it is natural that policy makers should seek to drive down the costs of pensions.
But does lowering the cost of pensions mean that consumers will buy more? That is what’s meant by price-elasticity. And the real policy imperative for this country is to get people to save more, before the demographics of an ageing population result in an insufferably large number of older people being supported by a shrinking working population.
You have to turn the clock back twelve years, to the beginning of the great Stakeholder experiment to see that pensions are not price elastic for the working population. Those were the days of “Government by focus group”, when New Labour made extensive use of closed doors focus group research to drive their policy reforms. On the subject of pensions, people in focus groups said they could not afford pensions.
Sadly, this message was mis-interpreted as meaning pensions were too expensive. Indeed, charges were high, with capital units often taking half the value of the first two years premiums. So Stakeholder was launched but, to the bemusement of policymakers, consumers did not flock to buy this low cost pension. That’s because when working men and women said they couldn’t afford pensions, they didn’t mean the charges were too high, they meant that other calls on their budget were more relevant and of higher priority to them.
This is why I take issue with some of today’s policy makers who suggest a uniform 30% rate of tax relief for pensions. For the basic rate taxpayer, this has the effect of reducing the cost of buying £1 in their pension plan from today’s 80p to an apparent bargain price of 70p. But if the product is price-inelastic for ordinary workers this will not generate further pension saving. The only additional saving is the extra gift from the taxman, and last time I looked, the taxman didn’t have any spare cash to give away.
Conversely, it would seem that pensions are price elastic when you move to the higher ends of the income scale, where spending and saving are much more discretionary. We are beginning to see the effect of the Chancellor’s 2009 Budget, which for higher earners increased the price of getting £1 into a pension plan from 60p to 80p. We are seeing a backlash from consumers, an outcry from advisers and a surge in demand for alternatives to pension provision.
As one IFA put it to me recently, he uses the end of tax year client visit to lower his client’s tax bill. Traditionally pensions have been great at doing this. The client writes a cheque to the pension company, he gets basic rate tax relief credited to the pension scheme and higher rate relief set off against the end of year tax bill. It’s wonderful. If a client is facing a £10,000 tax bill at the end of the year, all he needs to do is write a cheque to the pension company for £40,000 and the tax bill disappears. Meanwhile, that £40,000 cheque turns up in the pension scheme as £50,000!
This particular IFA is going to use Venture Capital Trusts this year to magic away clients’ tax bills. Other advisers will suggest alternative strategies, but what is clear is that the lure of the pension contribution to high earners has lost much of its lustre. So here, pensions are price elastic.
Where does this leave us with intermediate earners, those on salaries of between £50,000pa and £150,000pa, today’s typical 40% taxpayers? They may not all have an IFA, but they are comfortably off and able to re-direct spending and saving in a discretionary manner to pick up the best bargains.
So pensions will be price elastic for most 40% taxpayers. Which means that if their tax relief is reduced to a uniform 30%, they will save less in pension plans.
Beware the siren cries of those advocating a new uniform rate of tax relief for all savers. Behind their banner of “fairness” lies an
attack on pension savings, which will reduce the total amount our nation sets aside for its future retirement.