Following last week’s publication of a briefing note by the Pensions Policy Institute (PPI) on pension tax relief, our taxation policy adviser, Dan Gallon has blogged on the background to the research and what it might mean for future policy development.
Every few years pension tax relief hits the radar. With £53 billion[1] of relief provided in 2017/18, it obviously stands out to Government, think tanks and others as a significant cost that is hard to ignore. With such sums at stake and continual speculation about how the Government will pay for Covid-19, it is unsurprising that it has led to media speculation that pensions tax relief reform could help to balance the Treasury’s books.
This is not new. In an economic downturn it is natural that attention is drawn to the fiscal levers that the Government could use. But pensions tax relief is a particularly interesting one. Relief plays a vital role to incentivise people to save for a pension and boosts the adequacy of those savings. Without this Government “top-up” pension pots would be even smaller than they currently are. In the long term, this risks people not having enough retirement savings to have the retirement they hope for. However, relief is one of the biggest costs for the Treasury and the amount of this relief is growing year on year. Any change to the system could be complicated, confusing and costly. So it is timely that research conducted by the Pensions Policy Institute (PPI) tackles some aspects of the pensions tax relief jigsaw.
No significant analysis has been done on pensions tax relief since 2015/16, despite the last 5 years of pension policy seeing the growth of automatic enrolment and introduction of pensions freedoms. The PPI’s analysis is an important step to help inform the debate and ensure that subsequent discussions are evidence-based. With pension tax relief reform, we cannot risk a pensions freedoms style top-down government imposition which leads to unintended consequences.
Defined Contribution (DC) schemes are the focus of the PPI analysis. The results provide some fascinating insight into the impact that the current system has on the distribution of tax relief. The gender and age-related impacts are stark. 42% of people who contribute to a DC pension are under 40, but they only receive 27% of the available tax relief. Of course, today’s younger cohort are likely to receive more in relief when they are older. But they might not, and policy would ideally smooth savings over time rather than put maximum pressure on saving in later years. 71% of DC tax relief is granted to men, as they pay 69% of the contributions. Although many of these men will be in households which share wealth with women, they won’t all be, and pension outcomes after divorce are a known problem. The introduction of auto-enrolment has also not tipped the distribution of relief significantly back to basic rate taxpayers. Despite basic rate taxpayers making up 42% of total DC contributions, they only receive 26% of the pensions tax relief related to DC pension contributions.
These results may not be unexpected outcomes of the current system, but there are valid questions as to whether they exacerbate existing inequalities and are meeting the policy objectives. The classic comparison is whether something would be done this way now, if you were starting from a clean sheet of paper. I suspect it would not resemble the torn and tattered parchment we currently have which bears more evidence of a patchwork of corrections and changes than my 6 year old daughter’s schoolwork.
Could a flat rate alleviate some of the issues with the current pensions system of which there are many, with the Net Pay anomaly being a well-known one? Well, yes, some issues including that specific one, would be fixed, but how you apply it to all DC arrangements remains unclear. Nevertheless, reducing some of the current distortions is likely to be a priority in any meaningful reform of tax relief in the future. Behavioural changes that could result will also be important to understand. However, in a new world of low returns on investments, tax relief may become ever more important and encourage saving within a pensions wrapper.
The PPI research only tackles one piece of the jigsaw. For context, DC schemes account for £9.3 billion of government spend on pensions income tax relief. The rest of income tax relief spend (£20+ billion) goes to Defined Benefit (DB) schemes. Previously you could make an educated guess that DB pensions made up the majority of the relief, the PPI’s research proves and quantifies this.
Open DB schemes other than in the public sector are rarer than a Joelinton goal for Newcastle, and so the political elephant in the room swiftly comes into focus. If the Government wants to make savings to pensions tax relief, changes to DC schemes alone will have only a limited impact and it will need to tackle changes to tax relief for DB pensions as well. Be under no illusion, this will require serious political will. The pressure on the Government over doctors’ pension tax positions led to the application of a very large sticking plaster, nearly doubling the point that the annual allowance taper kicks in. It’s difficult in this context to see the Government willingly hitting NHS workers, teachers and others with tax increases that disproportionately affect them.
The PPI report is a useful start to inform the debate, but it provides evidence and analysis rather than the answers. As a result, it has triggered some really good, informed commentary about the complexity of changing the tax relief system.
Jon Greer from Quilter has warned of the dangers of decoupling a flat rate relief from the income tax bandings. If this was done, then that would lead to an additional lever that the Chancellor could flex to bring money in, while discouraging long-term savings. Similarly, Andrew Tully of Canada Life has raised the issue of changes needing to cover both DB and DC. In my opinion, the equivalence of outcomes needs to be looked at rather than applying identical tax controls to two very different systems.
If speculation around changes to pensions tax relief transitions to actionable change, expertise in our sector must be used to help shape a system that, like the very nature of pensions, is fit for the long term. A meaningful formal consultation over any proposed changes is essential.
While the direction of Government policy is up in the air, now is the time for the pensions industry to be on the front foot, informing political debate and exploring the nuances of possible solutions.
[1] Including national insurance contribution relief and gross of offsetting income tax on pension payouts