At the beginning of this year, the conversation about tax relief turned into something of a cacophony, yet it seems to have diminished to little more than a whisper following the absence of any significant announcements in the Chancellor’s March Budget.
To recap, the UK’s private pensions system is structured around the principle that tax relief is granted up-front, investments are largely untaxed, and then retirement proceeds are taxed as income – ‘exempt, exempt, taxed’ or EET as it has become affectionately known. Isas work in the opposite way, with money paid in after tax, but tax-free on taking the proceeds – taxed exempt, exempt, or TEE.
To a large extent, the debate centred on this issue – whether pensions should be altered to a model more akin to Isas. Many compelling arguments were presented for each side, and there were a number of compromises put forward, such as a flat rate of tax relief.
So why write about this now, if the government has confirmed that there will be no further changes?
In reality, there was a qualification in the announcement at the Budget, insofar as there would be no changes “at this time”. There is nothing sinister about that. It simply acknowledges that the reasons for the consultation in the first place largely remain, that is, the annual cost continues to rise and is equivalent to perhaps a third of the UK’s Budget deficit – most tax relief goes to higher earners, so many people do not see it as an incentive to save.
You could probably add to that list that the current system of tax relief is becoming increasingly complex, with a restrictive lifetime allowance (LTA) and an unpredictable correlation for higher earners between people’s income and the tapered annual allowance. Such iterative changes are clearly designed to contain the costs of tax relief, and will be effective in doing so, but add layers of administration for employers and their employees in managing their pension affairs, year-on-year.
Despite there being no further changes to tax relief announced, we did see the proposed introduction of the Lifetime Isa (Lisa). This in itself has become something of a discussion in the debate about any move from an EET to TEE model for pensions. Some say it is the Trojan Horse which will slowly replace the current pensions system.
Whether or not that is the case will be something for the current, or indeed a future, government to decide, as that would almost certainly have to be a fairly long-term vision.
Some say the Lisa provides a direct challenge for pensions and auto-enrolment (AE) now, with extremist views suggesting almost everyone under the age of 40 will opt for this in favour of their qualifying workplace pension. I do not buy that. I have not seen any evidence that the help-to-buy Isa – arguably a micro version of the same thing – has increased pension opt-outs. More importantly, AE is not predicated upon people making discerning judgements about the relative merits of the pensions tax wrapper; rather, it relies on the behavioural science behind the nudge. The policy then counts on trustees and governance committees to ensure that the workplace pensions into which people are enrolled are adhering to the rules and providing value.
If someone does care to look at the numbers, it seems almost universally true that the workplace pension is better for people – if they are saving for retirement – than the Lisa. The latter, of course, is favourable for those people who simply want to buy their first house and need to muster up a deposit.
AE would be fundamentally undermined if the Lifetime Isa was deemed to be favourable for retirement saving, rendering the principle that you can put almost any employee into a workplace pension flawed.
But the Lifetime Isa does not try to outdo pensions for retirement purposes, nor has it been placed within the AE framework.
So what next for tax relief?
The debate will undoubtedly resurface, but, just as the reasons for having it in the first place have remained, so have the problems with making a major change.
The arguments in the short term centred on the relative merits of applying different models as to how they will play out for people in different tax positions. Lots of work was done to look at people whose tax status (basic, higher or additional ratepayers) changed throughout their lives. There were many attempts to ensure there were no cohorts who would be worse off under different scenarios. However, it was never a condition that no one would be worse off, and if you assume it is not a zero-sum game, then someone must bear the cost of reducing government incentives. Probably those with the ‘broadest shoulders’.
The longer-term considerations are perhaps a little more interesting, and beg a more philosophical – even moral – discussion. Breaking the link between tax relief and income tax changes the deal; pensions could no longer be described on the basis of ‘deferred income’. And removing taxation in retirement removes one of the key reasons people do not fully encash larger pension pots. Should tax serve as a natural break on activity that could be harmful to those making decisions about their money?
Also in that mix is the question of how society is structured to pay for its collective welfare. If we increased taxation on people during their working lives in favour of removing it for those who are taking their pension, would we simply end up with an increasingly large population of people in retirement who neither contribute through work or taxation? Some say that would be a fairer system. But we would never have any guarantee that a future government saw it that way.
However, putting politics to one side, the biggest reason for not making a change now is to avoid disrupting the passage of AE. Just over three years into this great ‘nudge’ experiment, more than 100,000 employers have enrolled more than 6m employees. And it is going remarkably well, with around 90 per cent of those enrolled staying in.
This year is arguably the biggest test yet, with around 0.5m employers setting up pension schemes in the space of just a few months. That is probably more schemes than had been established prior to that since the dawn of time.
It would be a very brave decision to change the rules of the game at this point. As such, the government’s decision to avoid doing anything just now was a welcome one.
Jamie Jenkins is head of pensions strategy of Standard Life
| Key points |
The UK’s private pensions system is structured around the principle that tax relief is granted upfront. There is no evidence that the help-to-buy Isa has increased pension opt-outs. The biggest reason for not making a change now is to avoid disrupting the passage of auto- enrolment. |