The recent Autumn Budget seems to have included a conscious decision to do nothing when it comes to addressing the savings gap, especially for the younger generation and the millions of low paid or self-employed not impacted by pensions auto-enrolment.
To what extent do employee benefits reflect what employees actually want? Within the context of retirement benefits, the answer very much depends upon which generation is being considered.
Most baby boomers, relatively speaking, are comfortably provided for, whereas provision for Generation X (currently aged 35 to 45) is decidedly mixed. Millennials (those aged 15 to 35) are, however, on the rack. They are faced with unaffordable housing, college debts, fragmented careers, earnings stagnation, zero hours contracts, minimal defined benefit (DB) provision (other than the public sector), a rapidly retreating State Pension age and, perhaps most challenging of all, increasingly having to support an ageing population.
Consequently the government’s inaction in the Budget is intriguing. Despite the UK’s savings gaps, millennials are still left confused or undecided, which inevitably means inaction. With 50% of the workforce being millennials, by 2020 it’s critical for employers to get involved and encourage good savings habits via the workplace.
Almost invariably, workplace savings arrangements involve a savings vehicle residing within a pensions tax framework, with tax relief on the way in the form of Exempt, Exempt, Taxed (EET). But pensions products are increasingly at odds with how millennials, in particular, are living their lives.
Numerous surveys evidence that the under 40s prioritise saving for their first home over contributing to a pension. The lure of tax relief on pension contributions is insufficient to overcome pension products’ complexity, cost and inflexibility, there being no access to contributions until 55 (57 from 2028). In addition, the widespread distrust of the pensions industry is often cited as a deterrent.
Consequently, many millennials are eschewing pensions in favour of the ready access offered by ISAs. ISA savings are made with post-tax income, but withdrawals are tax-free, so ISAs are Taxed, Exempt, Exempt (TEE).
Over the past decade, stocks and shares ISA subscriptions have increased by 115%, to £22.3 billion in 2016-17, taking their total market value to £315 billion. In the same year an additional £39.2 billion was subscribed to 8.5 million cash ISA accounts, taking the ISA cash mountain to £270 billion.
Conversely, in 2016-17, individuals contributed only £9.4 billion to private pensions schemes (a figure which includes basic rate tax relief), which is down 8% over the past decade. Official data excludes self-invested personal pensions and small self-administered pension schemes, which attracted perhaps another £5 billion.
Clearly, engagement with ISAs is high, which was confirmed by industry surveys and acknowledged by the previous Chancellor when he raised the annual subscription limit by 31%, to £20,000 from April 2017.
Importantly, the ISA brand is still reasonably trusted. However, until recently choosing to save in an ISA rather than a pensions vehicle required foregoing an upfront incentive, in return for ready access. But for millennials this is no longer the case.
The Lifetime ISA (LISA), introduced in 2017, is available to those aged between 18 and 39 (millennials). Uniquely, it combines a 25% upfront bonus with ready access to savings (including accumulated bonuses) when purchasing the first home. And post-60 drawings from a LISA are tax-free.
Consequently, although the LISA’s tax treatment is ostensibly TEE, for the 92% of the under 40s who are basic rate taxpayers it is effectively entirely tax-free, therefore akin to EEE. The 25% bonus, being economically equivalent to 20% Income Tax, effectively neutralises basic rate Income Tax paid before contributing to a LISA. The front ‘T’ is, in reality, an ‘E’ for basic rate taxpayers.
Remarkably few people appreciate this fundamental LISA attribute, one with which the pensions framework cannot compete. The latter’s effective tax rate is 15% for basic rate taxpayers, after taking the 25% tax-free lump sum into account.
Clearly, for most of the under-40s, the LISA is the most relevant and tax efficient vehicle within which to save. It also offers the prospect of boosting employee engagement with saving: ISAs have their owners’ names on them, which engenders a sense of personal ownership. People refer to ‘my ISA’ but they de-personalise their membership of ‘the company scheme’.
An extraordinary 39% of auto-enrolled scheme members are unaware that they were a member of a workplace pension scheme. Furthermore, 95% had never tried to change their fund, 91% did not know where their funds were invested, 80% did not know how much was in their pension pot and 34% did not know who their pension provider was. Very few have identified a beneficiary, should they die. Personalisation is a prerequisite for engagement.
Ideally, savings derived through work should be as personal as a bank account, unencumbered by the jargon and paraphernalia of pensions. Being in control is closely allied to being motivated, and therefore engaged.
Employers have long complained that their pension contributions are undervalued by employees, and therefore represent poor value for shareholders.
Employees should be offered an alternative, that of having their employers’ contributions paid into a Workplace ISA (a term that has no formal definition). For the under 40s, this should be in the form of a Lifetime ISA, provided through the workplace.
Automatic enrolment (AE)’s statutory minimum employee contributions are currently ramping up; they are set to quintuple by April 2019 (from 0.8% to 4%). Meanwhile, many people are continuing to experience stagnant earnings growth, and perhaps rising mortgage rates, leading to disposable incomes being squeezed.
In addition, an increasing number of small and micro employers are reaching their AE staging dates, many without HR departments to dissuade employees from opting out.
Furthermore, more than half of the working age population is ineligible for auto-enrolment, including 23% of all employees (plus 4.6 million self-employed). People with multiple low-paid jobs (disproportionately female) are essentially shut out of AE.
The £10,000 minimum earnings threshold; the inability to aggregate multiple incomes for AE contribution purposes; and the use of band earnings for determining contributions, all conspire against the low paid. Consequently, many miss out on AE’s employer contributions, as well as tax relief on their own AE contributions. These rules serve no consumer purpose.
Ideally a Workplace ISA would fall within auto-enrolment's legislative embrace, and enjoy the same consumer protections (including the charge cap).
It would provide employees with a degree of flexible access that would discourage them from opting out of auto-enrolment. And because the LISA’s bonuses are disconnected from tax-paying status, an upfront incentive would then be available to those on low incomes, even for those with total earnings (from one or multiple jobs) below the Personal Allowance.
There is much to be said for making a Workplace ISA available, especially to millennials in the form of a Lifetime ISA. It has the potential to help catalyse much greater engagement with saving, especially with the convenience of saving via payroll deduction, and could be efficiently delivered through the new breed of digital wealth platforms (‘robo-investing’), which are accessible and engaging to use.