How can the financial services sector help reduce asset inequalities faced by Generation Rent?
by Inline Policy on 20 Apr 2016
In most parts of the world, the Millennial Generation has more personal and economic freedom than any which preceded it, but is also facing a squeeze on wealth and assets not experienced in the last 70 years. The UK Government’s Social Mobility and Child Poverty Commission considers that social mobility is in danger of going into reverse in some areas of the UK, and that inequality of assets between generations could worsen matters.
The generational social contract worked as follows for many over the past seven decades: work hard after university/college/apprenticeship, save for a first home deposit, get on the housing ladder, save for a pension, have higher living standards than your parents’ and grandparents’ generations partly through house asset price appreciation, enjoy the benefits of a guaranteed income in retirement in your own property on retirement, underpinned by a new cohort of taxpayers entering the labour market, paying taxes to support the state pension and social security system. But now that deal is breaking down, with big implications for Government policy and the public finances, future retirees and the financial services industry.
Britain’s savings ratio is at a 50 year low. House prices are continuing to surge ahead – in the South East of England by 11.4%, East of England by 10.3%, and London by 9.7%, in the year to February according to the ONS, while the proportion of 26-30 year olds in the private rented sector rather than owner-occupiers has risen from 9% in 1987 to 39% in 2014. The low rate of return on savings added to higher property prices, particularly in London, the South, and East of England, makes reaching an average deposit level of around £49,000 unattainable for many younger people in these regions. A recent Social Market Foundation paper in February floated the possibility of property crowdfunding within the wrapper of the Innovative Finance ISA or Help-to-Buy ISA (which will be folded into the new Lifetime ISA by 2020) as a means of allowing those saving for a deposit to invest in a product tracked to rising house prices. It also pointed to the unmet demand for new housing in the last five years of around 645,000 homes which, notwithstanding the development of new savings products, further inflates house prices.
What are policymakers and the financial services industry doing to overcome these barriers to building up assets for Britain’s under 40s? The Government’s approach has centred around the Individual Savings Account (ISA) model, promising to match 25% of the annual amount invested by savers under the age of 40 in a new Lifetime ISA product from next April, up to an annual limit of £1,000 matching for £4,000 saved in each financial year. The account can be drawn upon by savers for a deposit on a first mortgage on properties worth up to £450,000, and again at any point after reaching the age of 60. New entrants to the savings market, including rising Fintech startups, will be interested in offering this product and contributing to the discussion over its design. The Red Book accompanying Budget 2016 reveals that the new policy together with raising the annual ISA allowance to £20,000 a year will cost an additional £170m in the first year of its introduction next April, £330m in 2018-19, £590m in 2019-2020, and £850m in 2020-2021 – a reasonable amount of new Government incentives on savings.
On pensions, after reforms of the UK state pension are complete, the resulting foundation pension will be worth around 30% of average earnings. As the head of BlackRock recently said, with bond yields at historic lows, younger savers under the age of 35 need to be investing around £600-£700 a month to enjoy the kind of £30,000 second pension that many of their parents enjoyed on their retirement. If incomes in retirement are lower for future generations of pensioners but housing costs remain elevated owing to larger numbers of people renting into retirement, will it be the state or future taxpayers who may have to pick up the tab?
With the move to auto-enrolment into workplace pension schemes fully in place by 2018, most people in work and their employers will be making some provision for retirement savings, with only one in ten having chosen to opt out thus far. Around 70% of new pensions taken out have been defined contribution rather than defined benefit. The quality of these pension products, now potentially open to as many as ten million savers by 2018, is yet to be fully tested.
The Chancellor announced in 2015 that he would consult on further fundamental pension reform, following the changes in annuities rules, to potentially abolish tax relief on pension savings and returns and to replace it with an-ISA style plan where pension savings would come from taxed income, but face no further taxation liability thereafter, including after conversion to an annuity. The proposals were not widely welcomed, with the National Institute for Economic and Social Research concluding they would lead to a fall in pensions savings, frontloading the tax burden onto younger households, would damage overall saving and consumption by this group, and reduce cross-border labour mobility as most other OECD countries have a form of pensions tax relief. The Institute for Economic Affairs was also firmly opposed. The move to an ISA-style system would have increased taxes on higher earners, creating many losers, although lower and middle income savers would have seen pension savings grow.
The plans were dropped in this year’s Budget. But the issue of how the £35bn in annual UK pension tax reliefs ought to be spent in order to promote a broader pension savings culture particularly among those with little savings, and given that private pensions will have to do more of the future heavy lifting in sustaining living standards in retirement, remains a live one. The Resolution Foundation in its research has called the present system of pension tax relief highly regressive. There have been several calls to make the system more progressive and to increase savings incentives among those on middle and lower incomes by restricting pension tax relief to a flat rate instead of at the saver’s highest marginal income tax rate. This would mean less tax relief would accrue to those on the highest incomes, with currently the top 1% of earners receiving 13% of total pension tax relief, the same as the entire lower half of the income scale. Top and additional rate taxpayers in 2013-14 constituted 8% of the population aged over 16, and 30% of pension savers, yet received 63% of available pension tax relief. If the plans were to be revenue neutral, relief would need to be restricted to a flat rate of 29%.
The Great Recession has created a radically different climate for saving and acquiring housing assets for younger people. It has proven harder to get on the housing ladder due to lower savings levels, higher deposit requirements and surging house prices; issues of supply still require action from the construction sector, planners and Governments; and pension reforms and weak bond yields make daunting demands on younger savers building for retirement. The challenges are steep but resolvable. It will require concerted action from policymakers and the financial services industry to ensure that the prospect of higher living standards, access to the housing market and other assets, and the ability to plan for a financially secure post-work life, remains open for the UK’s under 40s.
Photo (CC BY 2.0)