Rachel Reeves turned your pension into Hotel California

In today’s issue:

You can check out anytime you like, but your money can never leave
Governments will tax where the money is: pensions
Milton Friedman on Saturday’s Fortune & Freedom

For years I’ve been warning that pension funds are a trap. A haunted house that’ll slam its door shut the moment you step over the threshold. And then your money will be on a spooky adventure hosted by HMRC.

Well, last week the façade finally came crumbling down. The trap snapped shut. Millions of retirees and savers called out in anguish. HMRC began licking its lips. It can finally get its hands on the money it has long longed for.

Your pension fund really is a Hotel California after all. And not just because of the questionable things going on inside. Here’s the crux: you can check out anytime you like, but your money can never leave.

Apparently, people have been using the tax-free nature of inherited pension money as an inheritance tax planning measure. By contributing more than you’ll ever need, you can hand some of it to your heirs, inheritance tax free.

Well, anyone using the ploy learned the hard way what happens when you rely on a loophole that can be closed.

The Chancellor’s announcement that inherited pensions will become taxable under inheritance tax is just the latest example of how the government will bleed your pension dry. But it’s the most blatant one yet.

I wonder if pension savers and investors will wake up to other similar threats?

Will the lump sum allowance become taxable or further constrained? Will early retirees lose tax breaks? Will your fund be forced to invest in government bonds?

After the recent round of changes, no doubt retirees will be keen to spend their money while they can. Instead of saving, investing and passing it on…

But what happens when they run out?

The inheritance tax grab on pensions is just a small part of several bigger trends affecting pensions generally. Some of which all investors need to be aware of given the importance of pension fund money in the markets…

Who really pays?

Let’s take a quick walk down memory lane to get some context…

Unable to fulfill their promises of a prosperous retirement via state pensions, governments turned to companies to provide their workers with a pension.

But betting that firms would be around long enough to actually pay out proved a folly. And the burden of supporting retired workers even sank some big companies.

So the politicians decided to punt the idea of retirement on the stock market instead. As though the same risks don’t apply…

These days, people are largely responsible for funding their own retirement by saving and investing. But the government has made it easy for them by creating opt-out pensions and all sorts of tax breaks for contributing to them.

The idea was to use the returns offered by stocks and bonds to generate a prosperous retirement.

But if there aren’t enough taxpayers to fund a decent state pension… and companies aren’t stable enough to fund their workers’ pension… then how on earth is the stock market supposed to come up with the goods?

Taxpayers, workers, consumers, savers and investors are the same people. If there aren’t enough to keep the scheme funded, there aren’t enough.

The bond market, meanwhile, is merely a deferral of responsibility. It’s the government that has to pay up, whether it’s a pension or a bond.

Whether it’s taxpayers, companies or investors who are supposed to pay for your retirement, the whole thing feels like a pyramid scheme to me. It relies on demographic pyramids looking like… pyramids. That way the inflows from the large cohort in the middle of the pyramid (the workers) match the outflows of the small cohort at the top of the pyramid (the retirees).

If those population pyramids start to look like Jenga towers, it doesn’t matter who you were punting on, there won’t be enough inflows to cover the outflows.

There won’t be enough taxpayers to fund the pension.

There won’t be enough investors to buy the assets retirees plan to sell.

The maths is the same. Except taxes are compulsory while investing into the financial markets is not. Yet.

But it’s not all bad news… if you’re a politician trying to balance the budget. Well, cut your deficit to a more respectable level.

It’s not your money

The pension savings system created a vast sum of money, sitting in low-tax vehicles. Investors can’t pull it out until they retire. And even then, only slowly. So the money cannot escape. Politicians can do what they like with it.

Governments are in desperate need of more tax revenue. Where do you think they’ll look? They’ll follow the money.

Now the taxes on pensions are ratcheting up. It’s a classic bait and switch. The savers who did what the government asked and encouraged them to do – contribute to pensions – will have to pay up.

It’s also worth noting that this is a global phenomenon. Governments are all facing fiscal trouble. And most encouraged investors to take care of themselves by investing in low tax retirement vehicles.

Ironically, the idea was to reduce the burden on the state during retirement. Instead, the purpose has become creating a pot of gold the government can tax which cannot escape. Unlike non-doms and billionaire investors…

The bond market reminder about cake and eating it

The bond market didn’t like Labour’s budget. Yields on UK bonds surged. This is interesting because the same happened after Liz Truss’ budget surprises. Despite her policies being the opposite.

My point being that neither side of UK politics is pursuing fiscal policies that its lenders like.

If cutting taxes crashes the bond market… and now raising taxes weakens the bond market… what doesn’t hurt the bond market?

You’ll find the answer in Saturday’s Fortune & Freedom. It’s the one policy no politician in their right mind would pursue. Except that nutter in Argentina, of course.

Speaking of which…

A final word on why taxes don’t matter

Before you go, a quick follow-up to Saturday’s analysis. I explained why Rachel Reeves’ tax hikes don’t actually matter.

Not that I convinced anyone. But after much trawling through the internet, the quote I was inspired by finally popped up here:

“Keep your eye on one thing and one thing only: how much government is spending. Because that’s the true tax. If you’re not paying for it in the form of explicit taxes, you’re paying for it in the form of inflation or borrowing.”

– Milton Friedman

The point is, all government spending must be paid for somehow. It’s just a question of how: inflation or tax. (Borrowing is just a deferral of one or the other.)

Complaining about either inflation or tax will only land you more of the other one. The only effective way to lower the true burden of both is to demand cuts to government spending.

Of course, Labour did precisely the opposite last week. They increased spending. Not by a meaningful amount given the budget projections over the next 20 years are for spending to blow out. But it was clearly a step in the wrong direction. Our investment director John Butler explained why Labour’s specific spending changes are especially dangerous on Friday.

If John is right, it’s time for investors to get very defensive in their portfolios. He’s certainly preparing his readers. Find out how, here.

Until next time,