Pensions Tax Relief: Let's be bold and radical - 20% is fair for everyone
6 Oct 2015
The Chancellor is correct in saying we need to be radical.
In the Budget the Chancellor said that he was looking for radical reform of the tax treatment of pensions. We agree, we do need radical thinking. As HM Treasury has outlined in 2013-14, almost £50bn of tax was "forwent" paying for pensions tax relief, of which over £30bn goes to higher and additional rate tax payers. This is staggeringly regressive and expensive. That’s £30bn that could be used to pay down the deficit. Alternatively it could be used in more socially useful ways such as broadening out auto-enrolment to include provision for customers to be protected if they become ill, die or get made redundant. Furthermore it could be used to increase the National Insurance threshold. All three would be fairer, more productive and much cheaper than the existing regressive system.
But as the Chancellor makes his deliberations, I’d caution that we need to make sure that any changes are fair and produce economic and social benefits for everyone. After all, ensuring that everyone saves for their retirement is crucial. The truth is that while living longer has many benefits, if we don’t save enough, future Chancellor’s will have to deal with an even bigger fiscal headache. This is not another inter-generational unfair legacy we should be leaving our children or our grandchildren.
I am a strong believer in reforming the current system with a flat rate of pensions tax of 20%. That means maintaining the so-called EET-system – you pay no tax on your contribution or investment growth, but you pay income tax at your marginal rate when you access your pension in retirement. The alternative option in the consultation is TEE (where you are taxed upfront and pay no tax later). This to us does not look like it will have consumer support, which could mean the system unravelling as millions of pension savers realise their retirement income could be significantly reduce if a future Chancellor decided to tax their income at withdrawal, as happens now.
And it isn’t the current Chancellor’s fault, but it’s one promise he can’t make or keep – as he can’t ensure a future Chancellor will not tax people’s pensions at exit in 10, 20 or 30 years’ time. Indeed, if history serves as any proxy, since 1997 there have been over 1000 Statutory Instruments (legislative changes to you and me) relating to pensions, with hundreds relating to pensions taxation; the most famous being Gordon Brown’s pensions stealth tax costing billions.
The current pension system is looking brighter than it has in a generation. Auto-enrolment is one of the most successful public-private project in decades, it has reversed the decline in pension saving. It is the gold-standard in modern pension saving. Here at Legal & General we’re proud to have over 1.4m customers already automatically enrolled into our pension products with millions more to follow. Each and every saver is supporting a better retirement for themselves, their families and society more generally. That’s why we’ve put a self-imposed charge cap of 0.5% on our standard offering. It creates the right incentive for people to know that their hard saved money isn’t being lost in high charges.
The Chancellor has rightly said he wants to build on the success of auto-enrolment and create a sustainable system which enhances the incentive to save. Clearly, nobody would ideally want to pay tax on their pension savings which is why the overwhelming number of people (73%) would prefer to pay no tax at all. Having said that, only one in eight Britons (13%) say that the way pensions are currently taxed is fair for the whole of society, and almost half (49%) agree that there need to be changes to the way that pensions are taxed.*
So if Legal & General had to advise HM Treasury, it would tell them there are five things they should do:
- One nation, one rate: Irrespective of where in the UK you live, or what retirement savings vehicle you use, the amount of monetary contribution from the Chancellor should be the same. And the public seem to agree. When asked earlier this month, 64% of Britons felt that any changes to the pension system would need to apply equally to all pensions (including public sector pensions).*
- A decision for a generation: If somebody is saving for the long-term, they want a long-term product which is simple, easy and hassle free. Constant changes by the government make this hard to deliver, and in turn erode trust. That’s probably why when asked, 57% of those not yet retired thought the system would keep changing and 54% thought that changing the tax system now was just a stepping stone to increasing the tax that people pay on their pensions in the future.* Cross party support and a trusted system is essential.
- Keep it simple: The Government needs to move away from talking about tax relief and talk about a "bonus" for retirement saving. This isn’t about rates, this is about how it’s marketed. We believe a flat rate of pensions tax relief of 20% makes sense. One of the reasons it that the incentive can be explained as "save £4 and get £1 from the government".
- Make it sustainable: One of the key elements to sustainability is affordability. If the bill for the Government can’t be reduced to a level the public purse can support then we’ll be back here having the same debate well before the next general election. That isn’t good for anybody. So a flat rate of 30%+ is equally not sustainable, it’ll cost the Exchequer too much.
- Work with the gold-standard: For all new pension initiatives under consideration, if they don’t build on the fantastic momentum behind auto-enrolment and the hard work of employers and employees up and down the country, we shouldn’t do it.
And it’s because of this we’re calling for a flat rate of pensions tax relief of 20% within the EET system, which is re-branded as "save X, get Y as a bonus from the Government for free". At L&G, we think this is far more financially sustainable for the Exchequer, is easy for the customer to understand and works and supports retirement saving for this and subsequent generations to come.
We are supportive of the Chancellor's bold and radical policy, and encourage him to make the pensions system fairer.
* ComRes interviewed 2,059 GB adults online between 2nd September and 3rd September 2015. Data were weighted to be representative of all GB adults aged 18+ by age, gender, region and socio-economic grade.