Articles - How the Chancellor can attract investment from pension funds


The Chancellor of the Exchequer is due to give his Mansion House speech next week. In it, he is expected to focus heavily on how the Government plans to attract investment in the UK, from UK pension funds. Both the Association of British Insurers (ABI) and the Pensions and Lifetime Savings Association (PLSA) have produced reports on how increased pension fund investment in UK businesses might be achieved. Both have highlighted that a ‘carrot’ approach of incentives rather than the ‘stick’ approach of mandates would be preferable.

 What could the Chancellor announce?

 1. Radical reform of the tax treatment of pension investments, so that those pension funds that invest more in the UK get more tax benefits than those that do not. For example, pension funds are free of Capital Gains Tax (CGT). The Chancellor could introduce CGT for pension funds that do not meet minimum UK requirements.

 2. Make an individual’s personal tax relief dependent on how much of their pension pot is invested in the UK. This would also be quite radical and incentivise the individual. Currently, people receive tax relief at their marginal rate of income tax. The tax relief system could be reformed so that different levels of tax relief apply depending on where your pension plan invests, not how much income tax you usually pay.

 3. The Pension Protection Fund, the lifeboat fund designed to protect members of private sector defined benefit schemes should their employer collapse, could become a ‘superfund’, enabling defined benefit pension schemes to be pooled and giving access to one significant source of funding for British businesses. This idea was proposed by the Tony Blair Institute in a recent paper. The advantage of this is that members of defined benefit schemes do not bear individual risk for investments going sour - their pensions are protected by guarantees. (However pension savers with defined contribution pensions do not have the same level of protection).

 4. Local Government Pension Schemes (LGPSs) could be further pooled - and more quickly. This was proposed by the ABI in its report: ‘Put savers at the heart of plans to boost pension investment’. There are 86 Local Authority funds with around £400 billion of combined assets, according to the ABI.

 5. The removal of the charge cap on auto-enrolment default funds, currently 0.75%. The cost of investing in the kind of companies and projects that need investment is typically higher than the cost of investing in the kind of funds and companies that you usually find in a default pension fund. This is for a number of reasons, but one is that earlier stage, high growth companies and big infrastructure projects require more due diligence than established global mega corporations. In order to carry out the kind of investments the Government wants to see, a practical step would be to remove the charge cap. This could mean higher fees for some pension savers on their plans. The idea would be that this would also lead to higher growth, however, there is a risk the growth wouldn’t materialise for several years, if at all. This risk would be most acute for older savers, close to retirement.

 6. Incentives for pension schemes to create separate ‘UK growth plans’ within a pension provider’s range of options for savers. This would enable individuals to make the decision for themselves about whether they want to invest more of their own pension fund in the UK.

 7. Mandates for all pension funds to invest a given proportion in UK companies. It has been suggested that pension funds might be mandated to invest a given proportion of their default funds to UK companies. Currently, this proportion is around 4% or less. The amount mandated could be around 10%, for example. This would be the most draconian and least popular approach all round, not least because it could seriously compromise the duty of pension schemes to act in their members’ best interests.

 8. The relaxation of regulation around the kind of funds that pension schemes can invest in. Certain rules prevent pension funds from investing in illiquid assets (assets that cannot easily be sold) in many instances. Many of the UK investments the Government wants to promote are illiquid, so these rules would also need to be relaxed.

 9. Special incentives for younger savers. A study by the British Business Bank suggested that the greatest gains from higher returns could be felt by pension savers currently in their twenties, because of the long time horizon they have before they reach retirement. A plan that incentivises younger savers in particular with higher tax relief, could be more appropriate than one that also includes older savers, who may be closer to retiring and needing to draw an income, and therefore less able to tolerate volatile returns.

 10. A combination of some or all of the above.
 
 Becky O’Connor, Director of Public Affairs at PensionBee, said: “There are ways forward, but the solutions are ‘chicken and egg’: the investments need to be appealing enough to invest in on pension funds’ usual terms, but they might not be appealing enough at scale until they receive further investment.

 “The defined benefit pension universe could offer the most compelling and scalable potential initially. There are ‘low hanging fruit’ proposals already on the table, such as the Pension Protection Fund being turned into a super fund and the further pooling of Local Government funds. The advantage of focusing efforts in the defined benefit pension world at first, is that the risks of investment failure are not borne by individual members, as they would be in defined contribution schemes.

 “For defined contribution savers, for any initiative to invest their money to work, they need to be compensated for the greater risk they would face, potentially without having chosen it for themselves. The risk could be significant, especially for older savers, so chunky incentives would be required to generate the flows of capital the Government wants to see.

 “Transparency and controls over the kind of investments that can be made with pension savers’ money would also be vital.

 “The Chancellor has options, but picking the right ones at the right time, for the right kind of pension scheme and savers, will be a tricky course to navigate.”
  

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