You've probably seen the "Workie" adverts by now. The big monster, symbolic of the big issue (auto enrolment) that really shouldn't be ignored, being completely ignored by all and sundry.
Now I know that some people are acutely aware that the deliberations being had right now inside Her Majesty's Treasury on the fate of pensions tax relief is a massive issue but I fear some do not. But it is an issue that certainly shouldn't be ignored.
Last month I explained some of the background to the HMT consultation on potentially changing (or possibly even stopping) pension tax relief and highlighted just one issue in moving away from a system based on EET at marginal rate of tax. Here is a link to the article which includes definitions of important stuff like what is EET, TEE and flat rate.
I promised that I would continue to highlight some of the issues and to shine a light on the potential social and well as practical considerations associated with a TEE model.
One of the options discussed in the HMT consultation called strengthening the incentive to save (you can find it here if you want to) was to remove all tax relief on contributions paid in to pensions i.e. pension contributions by individuals would not receive the benefit of any tax relief as the contributions would be made from taxed income and no uplift for tax could be given by providers.
In return the current Government would say that the quid pro quo for no longer getting this relief would be that pensions in payment would no longer be taxed as income as they currently are.
They would also put in a Government Contribution to provide some incentive to lock your money away but this would likely be modest relative to the current HMT relief spend.
This might sound plausible but there are huge issues in this once you start to pick through what it would mean. Just to highlight a few issues to get us thinking before we go into the detail:
So just thinking a few of these points through…
If a TEE framework was adopted, the Government would need to "promise" that future pensioners would no longer pay income tax on the income drawn from their pension pot. Many may see that as a good thing but remember those tax receipts do pay for something - the public services that often pensioners rely on like the NHS, Care and Personal Social Services.
During a period of significant demographic change, with the retired population living longer and relying on public services more and more, it is evident that the TEE system would come under huge fiscal pressure.
The reality would be that the new system which started off as TEE could ultimately become TET - that is to say a future Government would need to renege on the promise not to tax the pensions in payment. If it did not, the alternative may be more unpalatable to many - the services would have to be removed, cut back or perhaps paid for at the point of need and Generation TEE would end up not having had tax relief and getting taxed too! Realisation of this is likely to undermine the pensions framework and could perversely discourage pension savings - entirely the opposite of the stated intention.
In terms of social harm and potential for social unrest / disillusionment with ones lot, it is also worth pondering:
These are really fundamental issues that have the potential to distort intergenerational fairness and to introduce moral hazard. It is essential that these points are not lost in any short term debate about budgets and current deficits/debt.
There are also a host of practical issues including:
This is naming but a few and when you start to get into the issues that would be associated with trying to make TEE work for any DB, hybrid, DC with guarantee for example it gets mind bogglingly difficult. Not just for mere mortals like me but for really clever people including those tasked with getting to grips with the possible options inside Government Departments. So much so in fact that many believe that if TEE were to go ahead, DB would have to be carved out in some way and remain in the EET regime. This would reignite the public versus private sector pensions debate once again with accusations that the Government were looking after their own (and public sector employee) interests while leaving less well funded private DC arrangements to carry the can.
I also promised a bit on market distortion too but as this article is already getting a bit on the long side, may I just invite everyone to think once again? So… if there is no tax relief on contributions (and is replaced by a much reduced incentive through a "Government Contribution") there will be billions less going into pension investments every year. I hope someone is thinking through what this would mean for markets, infrastructure projects and the like.
Perhaps something to have a further look at another time…
Strategic Insight Manager
Ronnie has worked in Financial Services for over 25 years with experience in customer service, pension scheme implementation, pensions policy and marketing. He's an Associate of the Chartered Insurance Institute, a Chartered Insurer and qualified to diploma level by the Personal Finance Society.