U.K. Budget Proposes Pension and Savings Changes

Evidence of a growing retirement problem in the United States continues to surface. As the graph below illustrates, private savings has fallen significantly in the last 55 years. And the United States isn’t the only nation facing retirement challenges. Last month, the United Kingdom released its budget recommendations and included savings and pension reforms that might prove useful to America as we craft our own reforms in coming years.

The most widely discussed savings reform in the U.K. budget proposal was an effort to loosen restrictions on what people can do with their defined-contribution (DC) savings upon retirement.

Under current law, British retirees can withdraw 25 percent of the funds in their DC accounts tax-free, but withdrawals on the rest are taxed at 55 percent. There are some exceptions for those with very small or large savings, but the large tax on cash withdrawals effectively requires most people to buy an annuity (on a tax-free basis) with their accrued savings; the annuity income is then taxed as regular earned income as it is disbursed.

This policy has faced public criticism in the U.K. because choices were restricted for retirees and ongoing low interest rates mean that annuities purchased today pay out much less monthly income than those bought several years ago. Despite these criticisms, advocates of the policy stress that annuities ensure a lifetime stream of income, decreasing the risk that retirees will outlive their savings and making them a logical approach for policy to encourage.

The new measure proposed in the U.K. budget would allow people to take out the first 25 percent tax-free (as it is today) and the rest at the applicable marginal tax rate (which is 20 percent for most), rather than at 55 percent.

Responses to the proposal were mixed. For example, one opposition party leader applauded the increased flexibility and choice, but raised concerns that retirees could end up running out of savings and needing to rely on the government.

Other pension and savings reforms in the budget include:

• Instituting free, impartial face-to-face investment advice for those retiring with a DC pension; and
• Launching new fixed-rate “pensioner bonds” for people aged 65 or over, which the budget claims will have “market leading rates.”

The U.S. defined-contribution system could certainly work better for many Americans, and these examples from abroad may be useful in developing our own much-needed proposals for reform in the future.

Alex Gold and Samantha Greene contributed to this post.