A subliminal message of Isas good and pensions bad

Are we having a review to solve the problem of encouraging people to save in pensions or are we having a review to get to a particular political position?

I am perhaps a bit of a cynic but when I hear that such and such a think tank has welcomed a move I always look for the epithet describing the political orientation of the think tank to locate me in the right part of the political spectrum.

I am, however, pleased to see the following in the consultation paper, and hope that this is a sign that we start from the right place:

“The government is clear that the conclusion of this consultation may be that maintaining the current system is the most effective method of achieving the aims described above. The current system is based on a simple principle – that taxation of pensions should be deferred until retirement.”

The review was introduced under the heading of “let’s make pensions more like Isas” and underlying it is an examination of the tax treatment of the two saving plans.

As we know, pensions have been taxed on an exempt-exempt-taxed (EET) basis while Isas are taxed-exempt-exempt (TEE) – but is there more to it than that?

Is there a subliminal message of Isas good and pensions bad?

If there is, I would suggest that this has not been down to the tax structure but more to the simplicity, marketing and lack of tinkering with Isas.

Let’s be cynical for a moment – giving tax relief upfront and taxing a benefit when it is paid (EET) does not look good for a government’s coffers, whereas taxing the input but paying out tax-free means that it will be some years before the income emerges.

Would it be possible that a government of one colour taxes the contribution with a view to allowing tax-free income, but by the time that income becomes payable we have a different government who is finding it difficult to balance the books?

TEE could become TET or even TTT- low hanging fruit?

Hopefully governments are not in this for their own short-term good – it is about finding a solution to the long-term savings problem.

The consultation is entitled “Strengthening the incentive to save: a consultation on pensions tax relief”.

There have long been two schools of thought.

One is that tax reliefs are an incentive to save, and the other is that they are a way to avoid paying tax twice on salary that you put away for the future – this is acknowledged in the foreword to the consultation.

Is tax relief seen as an incentive to save? I think many people do not even understand the system of tax reliefs.

If they did the bill to the Exchequer might be even higher.

The consultation suggests that incentives need to encourage pension saving but the crux is what incentives, for whom and how much will they cost?

In my view there are some earners who will not tend to save whatever the incentive – they will be lower earners.

Auto enrolment is the flagship policy for this group.

At the other end of the scale there will be higher earners who will save and understand the tax consequences and incentives.

There are limits here, namely the lifetime allowance and annual allowance.

The most problematic group is perhaps the so-called ‘squeezed middle’.

They might save if they can see and understand the incentives to do so, but if they do not see the value of such incentives many will be equally inclined to spend.

A big part of this consultation will be the behavioural science around saving and incentives – should the latter be tax relief, matching contributions or something else?

More and more I come back to the big picture – we are living in an ageing society and can produce any number of statistics to show this.

The replacement ratio (number of contributing tax payers to number of non-contributing retirees) is falling and the state pension has been reviewed.

If nothing else changes there will be even more pressure on the state and taxes will have to rise.

The alternative is to incentivise people who can to provide for themselves.

What is the best way of encouraging people to save, how much do we want people to save, what does it cost, can it be afforded and is it equitable?

Is there a relationship between the incentives given today and the saving to the state in the future?

Mike Morrison, head of platform technical at AJ Bell