Your IndustrySep 3 2015

Saving habits not down to a TEE

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

Last month I promised to share with you some of my thoughts on the latest Treasury consultation entitled ‘Strengthening the incentive to save: a consultation on pensions tax relief’.

Before doing so, it is worth reflecting on the fiscal challenges that the government faces. As Mr Micawber said in Charles Dickens’ David Copperfield: “Annual income £20, annual expenditure £19.19s.6d, result happiness. Annual income £20, annual expenditure £20.0s.6d, result misery.”

Alas, the UK is firmly in the realms of misery, and although the government is bravely attempting to move us towards happiness, the journey will be painful. Basically, as a nation, we are either providing or spending too much on government or we need to pay more taxes to sustain the services that the government provides.

The chancellor has a hard balancing act to manage, and pensions tax relief must be seen as an easy target. When reading the consultation paper, it is easy to identify opportunities for the Treasury to make savings. One option would be to change pension tax to a taxed, exempt, exempt (TEE) basis as used for Isas. So an individual pays contributions out of taxed earnings which are then allowed to grow tax-exempt and can be withdrawn tax-exempt too. Although in the long term this would not alter tax receipts much, the advantage would be the immediate tax ‘gain’ to the Treasury as no upfront tax relief would be given. One additional consequence of this approach is that the tax-free lump sum – typically 25 per cent – would effectively be killed off.

Despite the obvious advantages of this approach to current Treasury finances, I do not support a move to TEE for a number of reasons:

1. It would be politically and morally difficult to introduce this change without ring-fencing existing benefits which would add a further layer of complexity to pensions.

2. Individuals would feel cheated if they lost their tax-free lump sum – and many are depending on this to fund their mortgage repayment at retirement.

3. Frankly, there is already a lack of trust in the long-term nature of government policy, with different governments continually changing the rules and promises, and this would create a further lack of trust in pensions in general.

4. Individuals can already use TEE via Isas to save for the short, medium and indeed long term, although much of the short-term saving is probably nothing more than temporary substitution of taxed savings into a more tax-efficient vehicle (Isa).

Over the past few years there have been several individuals and bodies calling for a redistribution of tax relief so that the lower-paid have a greater incentive to save.

Non-taxpayers already enjoy ‘tax relief’ if they are in a contract-based defined contribution scheme, but the ‘net pay’ arrangements still favoured by many defined benefit schemes and some employer-sponsored (trust-based) DC schemes disadvantage this group. This needs addressing.

While I have some concerns about the idea of introducing a unified tax relief rate for pensions, on balance I am attracted by the idea, provided it is set above the basic rate. I believe that it offers the advantage of simplicity, and uses the ‘matching’ concept, which is already proving a success by Nest and other providers of auto-enrolment. In my view, ‘matching’ should mean: “For each £2 you invest, the government will add £1,” effectively giving 33 per cent relief for all. This would encourage basic rate taxpayers, while not disincentivising higher rate taxpayers.

A further attraction of this approach is that by unifying the rate of tax relief the chancellor, and future chancellors, would be able to vary the basic and higher rate bands without changing the pension tax relief band. Or the pension tax band could be varied and altered in conjunction with annual and lifetime allowances to make it easier to ensure the system was sustainable.

Finally, among the other points that my firm is making is the need for employers, employees and the self-employed to have access to professional financial advice – which is another subject in its own right.

Dr Peter Williams is an independent consultant and chartered financial planner