A summary of our response to the pension tax relief consultation
Change is in the air. In the first Budget of the new Conservative Government we heard of its tentative plans to change the way pensions tax relief works. I say tentative, because the consultation paper asked for views on what changes should be made, and indeed if the status quo should remain.
But despite this, the strong feeling is the Government has its eye on reducing the pensions tax relief bill and its number one suggestion is moving to a ‘taxed exempt exempt’ (or TEE), basis, similar to the mode for ISAs. This would mean contributions would be taxed, but money could be taken out tax-free.
We caution against any hasty action. There has been so much change in recent pension history that we need time to see these changes bed in before embarking on anything new. Automatic enrolment is still fresh, and we still have the ‘tail end’ to implement and the minimum contributions to increase before we can really assess the effect it has had on pension saving. Likewise pension freedoms are only six months old. We need to see what effect they have over the next few years – both in encouraging greater accumulation of pensions and how the money is spent and the effects that has on future pensioners.
Our view is the complexity (or otherwise) of pensions tax relief does not really affect savings behaviour. The current system – exempt, exempt, taxed (TEE) – is not complex. The fact employees get that there is an immediate tax break (whether they understand it completely or not) is a very positive factor. Removing this would receive enormous adverse publicity and all related policy changes would be treated with huge suspicion by the public who will feel their pockets have been picked. Furthermore, the ‘exempt’ nature of the retirement income would not be viewed as a certainty, and therefore vulnerable to reduction by a future government, leaving people feeling insecure about whether to save within a pension or not.
Moving to an alternative system – especially a TEE one – could also have a disastrous effect on the way people take their retirement income. Currently we have some constraints in the system - no access before age 55 and tax barriers to raiding the entire pot – to influence the way people withdraw pension savings. But removing these is highly likely to lead to indiscipline in terms of managing personal expenditure with short term needs and/or desires outweighing long-term prudence in terms of providing for old age. While the principles of self-determination and freedom of choice are important, governments also have a responsibility to create an environment and structure in society that caters for human weakness. A balance needs to be struck between freedoms on the one hand and on the other, the broad duties of care that would be attributed for example to trustees. Pension schemes are there to provide for retirement, and there must be rules in the system that reflect and support this fundamental objective.
So, what changes would we make? Firstly, if we – as a country - want to reduce the amount of money we spend on pensions we should consider the role of public sector schemes. The private sector has now moved to defined contribution schemes, yet the public sector defined benefit schemes are sustained at enormous cost to the taxpayer. We think the priority should be to tackle this and move to a more affordable and sustainable system for the public sector.
We also need to do more to address the huge advice gap that still exists. Doing so will help people optimise their pension savings and achieve the most effective retirement income strategies. Guidance alone is not sufficient and regulated advice provides vital protections for employees, trustees and employers, and must be desirable. As part of this the HMRC special allowance of £150 should be increased so that more can be done to help employers facilitate access to regulated advice.
Although we would advocate sticking with the status quo for pensions tax relief, we realise this may not satisfy the Government. If change is what it really wants then instead of moving to a EET basis, we recommend moving to a ETT one instead – by taxing non-dividend income within pension funds. The move towards ETT would create immediate income for the Treasury of around £7bn but spread the impact over many years and create the least amount of impact on individuals and employers from an administration and ‘perception of change’ basis.
There have been so many big changes to pensions in the last ten years – simplification, automatic enrolment, and pension freedoms – that we need a break to assess what the real effect has been. Only then can we ever be in the right position to gauge what impact a change in tax relief will have on pension saving in the UK and on the future wealth of our older population.