Ten years of SIPPs – the verdict

In today’s post, we look back on ten years of the “A-Day” pension reforms that opened up SIPPs to the masses.

Ten Years of SIPPs

This is the first and probably the last post on this website in which I say thank you to Gordon Brown. He made a lot of mistakes as Chancellor and later as PM, but one thing he got right was pension reform.

Almost  a decade before George Osborne’s Pension Freedoms, we had A-Day. Last week was its 10th anniversary and the FT had a CPD (Continuing Professional Development) feature on it to celebrate.

So let’s take a look back at the policies that changed my investing career.

Before A-Day

People under 40 won’t remember what the pension regime in the UK used to be like. Pensions were dominated by insurance firms who ran their own (limited) range of investment funds, many of which were dogs.

• More importantly, contribution limits were very low, particularly for young people.
• They were set as a percentage of your income rather than a fixed amount of cash (as with the current £40K annual limit).
• The percentages started low and increased as you got nearer to the end of your career.

This meant that if you earned a lot when you were young, you weren’t able to save much of it, and you couldn’t get much in the way of tax relief.

Why A-Day?

A-Day was about simplification and incentives.

• There were eight different pension tax regimes in place
• And people weren’t saving enough for retirement.

For a while, the changes seemed to achieve both though there has subsequently been a lot of tinkering with the system and things now feel as complicated as ever.

What were the changes?

The key changes were the merger of all the pre-existing schemes into a single scheme.

• An annual contribution allowance of 100% of earnings was introduced.
• A lifetime pot allowance (LTA) of £1.5M was introduced (this was raised to £1.8M before being subsequently cut back to the current £1M).
• The 25% tax-free lump sum on retirement was copied over from occupational pension schemes.
• Drawdown was also introduced though there were limits on how much money could be taken out each year, and annuitisation remained compulsory at age 75.

One change that didn’t happen was the inclusion of residential property within pension schemes.

• Gordon Brown announced this but then did a U-turn in the face of fears that it would cause a property boom.
• The property boom happened regardless.

Did the changes work?

The main goal was to get people to save more, and though they worked well for me (see below), they haven’t fixed the problem for the UK as a whole.

• There are now 1.4M SIPPs with assets of £175 bn – an average (mean) pot size of £125K.
• This represents 15% of the total UK pension market (including employer pensions).

Other sources report average (presumably median) savings for the over 45s are £55K, but to derive their expected income of £27.6K they would need closer to £200K.

Industry experts blame the gap on the constant tinkering with pension rules and people’s reluctance to lock money away until they are (at least) 55. Consumption and property are preferred to saving for retirement.

There was also a disproportionate benefit in the changes in favour of higher earners, so many lower earners were not motivated to change their behaviour.

Post A-Day changes

Since the “great simplification”, we’ve had endless tinkering with the system.

The biggest change was the removal of the annuity obligation in the Pension Freedoms, but we’ve also had loads of extra ISAs (Junior, Help-to-Buy, Innovative Finance, Lifetime), workplace auto-enrolment, the New State Pension and the proposed Pensions Dashboard.

• On top of that are the seven protections against the LTA cuts, plus restrictions on contributions from higher earners.

So we’re almost back to where we started in terms of complication, I’m afraid.

There has also been the unintended consequence that the removal of commissions for IFAs means that financial advice is now only available to those savers with larger pots.

• Robo-advisers are probably the best hope here at the moment.

At the same time, it’s now clearer to younger workers what they need to do:

• the base pension you can expect from the state is clearer
• the contribution from the employer is clearer, though it’s still too low at 8% pa (and there is no statutory provision for the self-employed)
• and the options at retirement are simpler and clearer.

Whether enough people are in the position to contribute what they need is another question entirely.

• And the LISA will probably prove a distraction away from pensions saving.

My Pensions Journey

Looking at my own history with pensions demonstrates the need for incentives.

My career developed quickly in my late twenties, and by age 27 I was earning ten times the national average wage.

I couldn’t put much of it into a pension, though.

• The official limit for under 35s was 17.5% of “relevant gross earnings”.
• The problem for me was that I was freelance, and the tax regime at the time greatly favoured taking dividends over salary.
• My effective limit was around 3% of salary.

This was also the year that ISAs were introduced.

• They were called PEPs (Personal Equity Plans) back then, and the limit was £2.4K – around 30% of the average wage, but only 3% of mine.

So the official limit for contributions into tax shelters was 20.5%, but I was only managing 6% – not enough to provide for retirement.

My earnings peaked in nominal terms at age 37, but I was still “only” on 10.8 times the national average.

• I could officially now put 20% into a pension because I was over 35,
• But I was still paying myself in dividends, so I was still only contributing 3.5%

The ISA limit was £9K by then – up to 60% of the national average wage, but only 5.5% for me.

So the official limit was 20.5% into the tax shelters, but I was only managing 9%.

Wages in my industry stagnated after 1999, and by the time A-Day came along, I was “only” earning five times the average.

I had by this point probably saved the equivalent of 20 years of average wages, including some pretty decent investment returns.

• Sounds good, but I had been working for 22 years at this stage, and had probably earned close to 200 years of average wages.
• So despite good earnings – more than enough to live on – and good growth, my cumulative savings ratio was 10%.

That’s not nearly enough to maintain living standards in retirement.

A-Day changed everything.

• Suddenly I could contribute 100% of earnings, with an annual limit of £225K (later increased to £255K but already way more than I was earning).
• In fact, company contributions could be more than 100%, which meant that a high salary wasn’t needed.

I started to put everything I could spare into my SIPP.

• Including my ISA, I was paying in more than 100% of my earnings.

Six years later, my SIPP was close to full, and I was able to stop working.

Conclusions

1. A-Day opened up pensions accumulation for a generation who had been poorly served by the previous system.
2. It also paved the way for the Pension Freedoms that opened up decumulation in a similar way.
3. But it failed to incentivise lower earners, so the general pension problem was not solved.
4. Workplace auto-enrolment is the government’s answer, but it leaves out the self-employed (again).
5. As my own journey shows, incentives make a big difference to savings habits.
6. But you need to take advantage of incentives while they are there, because the window might not be open for long.

A-day made a big difference to me, and to how quickly I was able to become financially independent.

• But it didn’t work for everyone, and the window is more than half shut again.

From me at least, here’s to Gordon Brown, and in particular to his SIPP changes on A-day.

Until next time.