Getting more people into work and keeping them there for longer was a thread that ran throughout last month’s Spring Budget. Chancellor Jeremy Hunt focused on childcare, state benefit reform and elements of the pensions tax relief system, such as the abolition of the lifetime allowance (LTA). But there was nothing more to add on the funding of social care.

Last year’s Autumn Statement, which confirmed the proposed £86,000 cap on social care costs in England would be delayed by two years, had apparently said enough on the subject for now.

This changes the discourse around building up a pension. It becomes a positive

However, while the government and local authorities in England take time to get their ducks in a row, people still need care that does not come cheap. Could recent proposals from the Association of British Insurers (ABI) — to allow pension withdrawals to be made tax free, or at a reduced rate, if used for care costs — be a realistic option for self-funders?

Footing the bill

According to the UK Care Guide, in March 2023 average residential care home fees were between £27,000 and £39,000 a year, depending on location and the type of care required. Costs increased to £35,000–£55,000 a year if nursing care was needed.

To put these figures into context, £27,000 a year equates to around £519.23 a week, which is not far off the latest Office for National Statistics figure for average weekly pay across the UK, which is £580, rising to £630 with bonuses.

Pensions and care costs should go hand in hand and should be incentivised

Some people qualify for care costs to be paid, in full or in part, by their local authority, but others with savings or assets above a certain level must foot the bill themselves.

Currently, money drawn from a pension to pay for care costs is taxed at a person’s marginal rate. For people aiming for a comfortable retirement as defined by the Pensions and Lifetime Savings Association, the LTA has also been problematic. At least that disappears with its abolition.

But, even before getting to this point and debating whether tax breaks should be applied, there is a hurdle. When saving for retirement, people do not tend to think about potential care costs in the same way they think about paying the bills and going on holiday — although they should.

“The cost of care is something people generally don’t consider until there is a need,” says Curtis Banks pensions technical manager Damien Bowler. “However, pensions and care costs should go hand in hand and should be incentivised.”

I’m all for it but, when you start to look at how it could be designed, it gets complicated

Bowler observes that advisers tend to have conversations with clients about meeting care costs, but he wonders if, outside financial advice, people are encouraged to think proactively about this.

“Consumer polling conducted by the ABI found 38% of individuals would expect to use private and workplace savings to pay for care, so incentivising these would be a good start. Rather than create another savings vehicle, why not utilise pensions?”

M&G Wealth head of technical Les Cameron agrees. People can already buy immediate-needs annuities that pay out tax-free income to go to a registered care home, he says, but these cannot be purchased from pension funds.

“Bringing some form of tax incentive into the pension system, where payments were used to fund care, would be good news for savers,” he says.

“This change would allow tax-efficient saving for two crucial later-life needs, without requiring the saver to choose what to prioritise in earlier life when they didn’t know what the future held.

“That important decision could be taken later when their circumstances were better known.”

A thorn in the side

Social care has been a thorn in the side of successive governments. Intelligent Pensions technical director Fiona Tait sheds light on why this may be the case.

Bringing some form of tax incentive into the pension system would be good news for savers

“It is not an easy nut to crack as people’s experiences of social care tend to be extreme.

“Not everyone will need it, but those who do can face substantial costs,” she says.

“The first issue means any funding solution needs to be conditional, and the second means it must also be capable of generating significant funds, if and when they are needed.”

With a focus on long-term savings, pensions provide a good fit. Currently, however, using pension funds to pay for care is not very efficient.

“Although pensions are not included as a capital asset in the means test for local authority funded care, pension income is taken into account,” says Tait.

She adds that the large amounts typically needed to pay for care mean the required withdrawals may be heavily taxed.

It is not an easy nut to crack as people’s experiences of social care tend to be extreme

“The ABI’s proposal would therefore seem very neat,” says Tait. “Clearly, greater levels of individual savings would be required, but this is a much easier task if people have more opportunities to benefit from the proceeds, whatever happens in their lives.”

Elsewhere in the industry, pension providers and advisers love the ABI’s proposal but point to practical complications that would crop up if trying to implement it.

There are concerns it could create an unlevel playing field for various groups: those who have already annuitised, those in receipt of defined benefit pensions and those who pay for care in their own home. That is without mentioning the word that is never far away from pensions: complexity.

“Pension schemes would need to split payments between the individual and the care home, treating each differently for tax purposes,” says Aegon pensions director Steven Cameron. “The last thing we want to do is add a further layer of complexity into the pension tax system.”

Rather than create another savings vehicle, why not utilise pensions?

Cameron would prefer people to make a transfer from their pension into a new product — a care fund or something similar — at the point of knowing they were going into care; he believes this would be simpler. However, another issue would need to be ironed out.

Changing the narrative

When people pay for care, some of that cost is for room and board, and some is for personal care. The local council may be willing to contribute towards the cost, with the individual paying any difference through a top-up payment. According to Cameron, it is unlikely people would receive tax breaks on all these elements, which could be complicated.

“I’m all for it but, when you start to look at how it could be designed, it gets complicated. Giving tax breaks on room and board would create an unlevel playing field for those paying for care in their own home. So you’d have to split that off as you wouldn’t get a tax break on it,” he says.

Cameron adds it is also unlikely people would get tax breaks on top-up fees to stay in higher-quality care homes.

The last thing we want to do is add further complexity to the pension tax system

However, some commentators are supportive of the ABI’s suggestion, despite the obstacles. Money Minder managing director Ray Black likens it to a pay rise; people would have a bit more money to use for care costs.

Black points out pension pots would stretch a bit further as a result and whatever remained after death could be passed on to loved ones, friends, neighbours or charities. In his view, this alters the narrative around pensions to someone having more options in later life.

“It changes the discourse around building up a pension,” says Black.

“It becomes a positive instead of the negative perceptions among people who think, ‘What’s the point of putting money in a pension? I’ll never have enough.’”

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