PRE-AUTUMN STATEMENT 2016: SUBMISSION FROM THE SOCIETY OF PENSION PROFESSIONALS  INTRODUCTION TO THE SOCIETY OF PENSION PROFESSIONALS 1)

SPP is the representative body for a wide range of providers of advice and services to workbased pension schemes and to their sponsors. SPP’s Members’ profile is a key strength and includes accounting firms, solicitors, insurance companies, investment houses, investment performance measurers, consultants and actuaries, independent trustees and external pension administrators. SPP is the only body to focus on the whole range of pension related services across the private pensions sector, and through such a wide spread of providers of advice and services. We do not represent any particular type of provision or any one interest - body or group.

2)

Many thousands of individuals and pension funds use the services of one or more of SPP’s Members, including the overwhelming majority of the 500 largest UK pension funds. SPP’s growing membership collectively employs some 15,000 people providing pension-related advice and services.

INTRODUCTION TO THIS SUBMISSION 3)

Given the forthcoming Autumn Statement, we wish to ensure that future fiscal policy continues to recognise the need for a sustainable pension tax system, which advances the consensus-driven pension policy goals of embedding sustainable long term retirement saving through autoenrolment, incentivising greater levels of saving, and seeking to avoid or minimise disruption for individuals and businesses.

KEY POINTS 4)

The tax system must support auto-enrolment into pension schemes, which is at a crucial stage in extending its reach. The tax system must not create disincentives to remaining auto-enrolled in the short term and in the longer term, as contributions increase.

5)

As part of maintaining good will to auto-enrolment and encouraging reasonable retirement provision, the tax system must also not alienate employers and middle-income individuals by penalising pension saving by anyone, who is not a basic rate taxpayer. Given the attractions of both instant gratification and immediate access to short-term cash savings, there must always be a reasonable advantage given to those who commit to locking up their money for long-term saving.

6)

Constant tweaking of the tax system adds to complication and reduces confidence in retirement saving.

7)

The tax-free pension commencement lump sum represents a straightforward, certain option among the complexity of an individual’s potential future retirement outcomes and choices.

8)

For these reasons the best course of action in the immediate term would be to make no changes to the tax treatment of pensions. Pension pots represent hard-earned savings as much as earnings represent hard-earned income and should not be looked on as an easy target to help meet government financing needs.

9)

If changes to the current tax system were to be considered necessary in the medium term, only those, which (a) do not pose a threat to auto-enrolment, (b) do not deter long-term retirement saving and (c) encourage more retirement saving should be pursued. Changes should be properly consulted upon and planned with sufficient time for a proper adjustment.

10)

Any move away from the current Exempt, Exempt, Taxed system, with income tax relief at the member’s marginal rate, would raise major transitional challenges and might make a return to separate pension tax systems for defined benefit and defined contribution inevitable. The resulting cost and complexity for schemes and HMRC should not be underestimated.

https://thespp.sharepoint.com/16/LC 4.7/Pre-Autumn Statement 2016 SPP submission fv.docx The Society of Pension Professionals St Bartholomew House, 92 Fleet Street, London EC4Y 1DG T: 020 7353 1688 F: 020 7353 9296 E: [email protected] www.the-spp.co.uk A company limited by guarantee. Registered in England and Wales No. 3095982

Pre-Autumn Statement 2016 Submission Page 2

Additionally, any further differential treatment of defined benefit and defined contribution schemes, already unequal in valuation against the Lifetime Allowance, would damage to the reputation of retirement saving. SUSTAINABILITY 11)

A pension taxation system, sustainable across generations, is essential.

12)

Sustainability needs to address the following questions:

What long term retirement saving goals does the government wish to incentivise? The Turner Commission addressed this question in some detail. Are these still the government’s goals? The current mainstay of pension policy, auto-enrolment, seeks to bring people into pension saving by capitalising on their inertia, at least as much as by incentivising them. This suggests that incentives should be aimed at encouraging more saving for retirement, rather than simply saving in itself.



Who does the government aim to incentivise? Successive restrictions on tax relief at the higher end of the income scale mean that increasing numbers of well paid, but by no means wealthy, people are being dis-incentivised to save for retirement through the pension system. At the lower end of the income scale the main disincentive to save for retirement, meaningfully or at all, is that more immediate competing financial demands mean that there is little or nothing left to save. How useful does the government consider that incentives can be for people in this situation, given that the new flat rate State pension will in due course probably provide a significant portion of their retirement income, particularly if the triple lock persists?



Recent significant changes to the pension system, i.e. substantial increases to State pension age and the introduction of auto-enrolment, have commanded a broad political consensus, which will undoubtedly contribute to their sustainability. The aim of political consensus should be reflected in any further debate on possible reform of the pension taxation system.



Broader changes, specifically the planned introduction of the Lifetime ISA and Help to Save will assist with a broader savings culture. However, there may be concern over the long-term inter-generational sustainability of the Lifetime ISA, given that these savings have an incentive equal to basic rate tax relief at the time of contribution but contribute no income tax to future governments, since the savings will be withdrawn tax free. As such the Lifetime ISA could be a limited supplement to existing retirement saving, but cannot be a substitute for it. A pure Lifetime ISA system would leave future governments having an entire retired population, which effectively no longer contributed any income tax but which benefited from state pensions, NHS and social care. Such a burden (given the aging profile of the population) could be inter-generationally crippling and force future detrimental tax changes.



To what extent might the government’s thinking be based on the idea that there ought to be a cap on the cost of pension tax relief? For example, expressed as a percentage of GDP? If this is part of the government’s thinking, it ought to be publicly shared. There is an existing precedent in the cost cap embodied in the public service pension settlement.



Any analysis of the cost of pension tax relief should take into account that emerging pension benefits are currently subject to income tax. A comparison of current tax relief to current receivable tax on pension benefits will not be appropriate here. What is required is an analysis of the relationship between the up-front tax reliefs and the value of tax receipts from the future pensions of the same individuals.



The cost to the government of the Lifetime ISA in the long term must not be met at the expense of tax relief for registered pension schemes. In the long term, pension tax relief in the current period is significantly recouped when retirement payments are made. Over that time period the Exchequer cost of the Lifetime ISA will emerge, because three-quarters of a pension pot is taxed in payment, whereas none of the Lifetime ISA pot is.



If a new system of pension tax relief was to be considered, particularly around a flat rate of tax relief, perhaps to incentivise basic rate taxpayers, it would be difficult to predict how great the incentive effect would actually be. It would be a matter of great concern if, after huge investment in reforming the system, higher than expected levels of saving by basic rate

Pre-Autumn Statement 2016 Submission Page 3

taxpayers meant that the system was then deemed to be no longer sustainable for the Exchequer without further modification. THE TAX SYSTEM AS AN INCENTIVE TO SAVE FOR RETIREMENT 13)

There have been suggestions that top-ups by the government (as with the Lifetime ISA) rather than tax reliefs, could allow individuals to better understand the benefits of retirement saving, as the government’s contribution would be more transparent. The current structure of providing tax relief at an individual’s marginal tax rate and being taxed at a potentially different rate in retirement can be confusing, but pension schemes have long experience of communicating the tax advantages of retirement saving in straightforward, non-technical language and, in fact, often already explain tax relief in terms of government top-ups, although it is evident that the relevant messages are not always understood.

14)

Given the so far low level of opt out rates under automatic enrolment, while there is certainly room to improve understanding of the support which the government provides for retirement saving through tax relief, the current tax system is clearly not a disincentive to remaining in a pension scheme. However, it does not incentivise saving enough to meet retirement needs.

15)

However, any reverse assumption, that withdrawing tax and national insurance reliefs would go unnoticed does not hold. Existing pension savers could see sharp reductions in their take-home pay and newly enrolled members could see significant reductions when they are auto-enrolled. In contrast, the benefit of the taxed contributions might be decades away (and might not be received if the saver died before taking retirement benefits). This would powerfully dis-incentivise pension saving among those affected. Alternatively, if the tax was recouped from the money otherwise due to be directed to pension funds by employers, the level of saving would be significantly reduced.

16)

For people paying tax at the higher and additional rates, the successive reductions in tax relief, through significant restrictions in the annual and lifetime allowances in recent years, have already greatly reduced their personal interest in pensions as a means of saving for retirement and this is a trend which we expect to accelerate with the introduction of the tapered annual allowance. As a very important consequence, this will probably also reduce their interest, where they are corporate decision makers on pensions, in doing anything more than achieving bare compliance in the provision organised for their workforce generally.

17)

For these people, it is not the system, but the frequent reduction of the tax relief available within the system, which has served as a disincentive.

18)

The greatest incentive to employees to save for retirement is often the contribution from their employer (we recognise that, for those eligible, the Lifetime ISA will offer an incentive to small self-employed sole traders, who as a group are not making any significant long term savings for retirement).

19)

Any change to the pension taxation or national insurance system, which effectively penalised employees generally for contributions made by their employer, would certainly be a disincentive to retirement saving.

20)

The pension commencement lump sum (tax-free cash) is another incentive to save for retirement, generally the more so the nearer to retirement. This is arguably the one area of pension taxation, which most employees understand. Further restricting it would reduce the incentive, but produce a gain for the Exchequer. However, it is difficult to envisage how this could be achieved quickly, if the government aimed to protect expectations of the availability of tax free cash embedded into so many retirement plans.

AUTO-ENROLMENT 21)

We attach huge importance to ensuring that auto-enrolment, which underpins current pension strategy, and which commands general support, continues successfully. Processes have had to be built to make auto-enrolment work. These have involved considerable costs.

22)

We cannot envisage how major changes could be made to the tax system without significant knock-on effects, and therefore costs, on the processes for auto-enrolment. There would be serious questions about how these costs could be met at the same time as the government is imposing strong downward pressures on charges in schemes used for auto-enrolment.

Pre-Autumn Statement 2016 Submission Page 4

23)

Any change to the pension taxation system, which left some of those auto-enrolled with lower take home pay than at present, would inevitably increase the likelihood of higher opt-out rates unless, for example, tax relief in the form of a top up to pension savings was perceived as an incentive by members.

ONE PENSION TAXATION SYSTEM OR TWO? 24)

The government should certainly recognise the differences between defined benefit and defined contribution pensions and aim for a system which treats members of each type of scheme fairly. The aim, however, should be to avoid having different systems for defined benefit and defined contribution because two systems would create significant confusion for members, who had both types of benefit, potentially subject to differing tax treatments. With the rapid decline in active membership of defined benefit schemes, increasing numbers of members will be in this category.

25)

It is fundamentally important that the two types of scheme are perceived as having equivalent treatment, even if they cannot be treated in exactly the same way. We would expect significant dis-satisfaction if defined benefit schemes, which are common in the public sector, but to which the great majority of the private sector are now unlikely to ever have access, were to be given significantly more favourable tax treatment than defined contribution schemes. Indeed, the reduction in the lifetime allowance is already treating those with defined contribution provision less favourably than those with defined benefits. For the latter, a pension of up to £50,000 per annum could be provided without breaching the £1m lifetime allowance now in force. However, for the former, the lifetime allowance would currently permit an annuity of somewhat less than £30,000 a year, with the same kind of inflation-proofing and dependants’ arrangements common in defined benefit schemes.

26)

There would also be significant administrative complications arising from separate systems for both HMRC and the pensions industry, including drawing the line between defined benefit and defined contribution provision (there are numerous examples under current pension legislation of where the dividing line is unclear) and in regulating transfers of benefits between the two systems.

27)

However, whilst acknowledging the potential complications of having two systems, any fundamental change to the pensions tax system may make this inevitable. This is because applying a radically different tax regime, and in particular one where benefit accrual is taxed when it is earned with no further tax then payable on the pension in retirement (a Taxed, Exempt, Exempt or “TEE” regime”), would not be practical for defined benefit schemes.

28)

To an extent, complications apply to any alternative regime where tax relief is not granted at an individual’s marginal rate or, in other words, any regime, which requires the amount of defined benefit pension earned in a given year to be determined for income tax purposes.

29)

For example, a system where a single rate of tax relief on accruing benefits is provided – e.g. a single rate of relief of 30% or 33%. Applying such a regime to defined benefit pensions would introduce most of the complexities associated with a TEE system, due to the need to determine the value of pension earned in each year for the purpose of income tax liabilities/rebates.

30)

The decline of defined benefit pension provision is well documented, and, given the stage we are at in the life cycle of existing defined benefit schemes, with very few open to future benefit accrual, it is hard to see how the difficulties and costs associated with a radical overhaul of the tax system can be justified.

POSSIBLE CHANGES TO THE CURRENT SYSTEM Moving to Taxed, Exempt, Exempt (TEE) from Exempt, Exempt, Taxed (EET) 31)

One possibility would be to move from the current EET system to a TEE system, like ISAs, with top-ups by the government.

32)

Given the state of the public finances, the government could be attracted by arguments for a move to TEE, since it would provide a context, within which to bring forward significant amounts of tax revenue.

33)

We are far from certain that the top-ups, replacing up-front tax relief, adequately compensate some pension members for the disincentive of reduced take home pay that TEE would cause. An

Pre-Autumn Statement 2016 Submission Page 5

additional drawback is the complete lack of certainty on whether retirement benefits would actually be tax-free when they came to be drawn. 34)

A move to TEE would represent a threat to auto-enrolment, because we would expect more people to opt-out in response to the reduction in take home pay, which it would involve for members of net pay schemes.

35)

Because of the potentially profound fall-out from it, we examine TEE in more detail in an appendix to this submission

Further reduction in the Lifetime Allowance and/or Annual Allowance 36)

Reductions in these two allowances are effective in reducing the cost of pension taxation relief to the government, but they also represent a significant disincentive to those affected to save for retirement through a pension.

37)

They have also hugely complicated the administration of pensions. However, a flat rate tax relief model, more generous to basic rate tax payers than the current system, and a less complex but lower Annual Allowance, could allow abolition of the Lifetime Allowance. It would be important however, to ensure that the cost of any abolition of the Lifetime Allowance did not result in the Annual Allowance being set too low. This is because there are substantial intergenerational issues, as those restricted by the Lifetime Allowance are older people, who have benefited from past tax relief, while those who would lose out by a lower Annual Allowance would be younger people, whose future saving would be more severely restricted.

38)

Further reductions to the Annual Allowance would, however, be unwelcome for small business owners and the self-employed, who tend to leave retirement savings until later in life – investing available funds in their businesses instead.

Change the Lifetime Allowance factor for defined benefit schemes 39)

It is widely understood that the current factor for valuing defined benefits for testing against the lifetime allowance understates the value of those benefits and a review of those factors could therefore be justified.

40)

The current lifetime allowance conversion factor for defined benefit schemes is 20:1, regardless of the age of the member at retirement. There would be logic in changing this, so that the factor remains at 20:1 at 65 but is, say, 25:1 at age 60 and higher still at age 55.

Abolish or further restrict the pension commencement lump sum/25% tax-free element 41)

There is no doubt that the pension commencement lump sum (and the equivalent 25% tax-free element in an uncrystallised funds pension lump sum) confers a genuine tax advantage on retirement saving.

42)

Abolishing it or further restricting it would certainly reduce the cost of pension tax relief over time. For example, if the pension commencement lump sum was restricted to £100,000 in aggregate, across all schemes or policies, under which an individual had benefits, most of those affected would keep their pension commencement lump sums within the limit and take the balance of their benefits as taxable income. However, there be would significant administrative complexity in establishing how much had been taken in the past, including amounts before the new regime was introduced.

43)

How quickly these cost savings could be realised would depend on the extent to which it was decided to phase in any changes to protect the expectations of the many people planning for retirement on the basis of the pension commencement lump sum as it currently exists.

44)

Generally speaking, there is little, which individuals can clearly understand if planning their retirement savings. Two certainties in the current EET system are that the income from final retirement savings will be taxed and that one quarter of these savings can be taken tax-free. Far greater uncertainty applies around the: 

value of final savings



annual income needed



individuals’ longevity (and the longevity of their spouse or partner)

Pre-Autumn Statement 2016 Submission Page 6

45)

The pension commencement lump sum represents a straightforward, certain option amongst the complexity of an individual’s potential future retirement outcomes and choices. The options available at the point of decumulation have become more complicated requiring complex and difficult decisions on how to take savings. Schemes provide support, which together with availability of Pension Wise guidance or financial advice, will help individuals make the right choices. However, both taxation and the tax-free lump sum are key features, which support making better choices around retirement.

46)

The ability to access a tax-free lump sum can be a major trigger for member/consumer engagement in pensions from their early 50s onward, because that cash can be used for tangible benefit. For example, mortgage/debt repayment, home improvements, helping children onto the property ladder. This tends to lead to greater engagement with the options for taxable income and, indeed the need for greater pension saving in many cases.

47)

Tax at decumulation restrains and shapes how funds are taken and mitigates the risk that it is inappropriately spent too quickly or all at once. The opposite risk is that the fear of running out of money leads to individuals to take insufficient funds for their basic needs. The availability of tax free cash encourages people to take that amount out, leaving the rest to provide their retirement income. This clearly identified tax-free amount offers individuals some flexibility to do with their money as they will and also encourages responsibility in decision-making. Contrast this to the position in Australia, where the availability of the entire fund tax-free is a strong incentive to draw it all at once, possibly using it to extinguish debt incurred during working life, but leaving insufficient funds to live on during retirement.

48)

Any restriction of tax-free cash could be perceived as a breach of the trust and legitimate expectations of savers. The consistent expectations set throughout the life of a policy or membership of a scheme, supported by the disclosure of regulatory required information, will be that a tax free amount can be taken. The closer to retirement date the more this option will be anticipated.

49)

This suggests that any removal or additional restriction of tax-free cash would need to be accompanied by grandfathering of existing rights, with associated complexity. Retention of the current tax-free cash offers simplicity, consistency and continuity in any change to tax treatment and would help retain some trust in the system.

A flat rate of relief 50)

A flat rate of tax relief of, say, 30% or 33% on employee contributions would not reduce take home pay for any basic rate tax payers and therefore avoid a major disincentive to remaining auto-enrolled, but ought to reduce the cost of tax relief to the government, because higher rate taxpayers would no longer receive relief at their marginal rate of tax.

51)

The general assumption (but see later in this section) is that this relief would need to be provided in all cases through relief at source, because the net pay mechanism is not compatible with a flat rate of relief.

52)

The Lifetime Allowance, and the complexities associated with it, could be abolished, because anybody paying tax at a rate higher than the flat rate of pension tax relief and making pension contributions would effectively provide a net gain to the Exchequer.

53)

A flat rate of relief at a suitable level would provide an upfront incentive to save for retirement to those paying tax at less than the flat rate of relief.

54)

The same rate of relief could be applied to employer contributions. This would in effect end salary sacrifice as a valid option, but it would also undermine the value of what we consider to be one of the main incentives for retirement saving, i.e. the employer contribution.

55)

The disincentive effect of a flat rate of relief on those paying income tax at more than the flat rate could be partially off-set by the retention of the pension commencement lump sum. Here it is important to note that the level of flat rate relief would be crucial. Combined with one quarter of a retirement fund being tax-free, a flat rate of tax relief of at least 30%, but preferably 33%, could still appear to be a fair deal to higher rate taxpayers. If a lower rate of relief than this was offered, many higher rate taxpayers would question if saving for a pension was worthwhile and, over time, this could significantly undermine long-term saving, with employers no longer thinking it

Pre-Autumn Statement 2016 Submission Page 7

appropriate to sponsor more than automatic enrolment levels of saving. Exchequer of a flat rate of 33% could be managed by a cap set on the relief.

The cost to the

56)

Net pay arrangements are built into the architecture of a significant number of auto-enrolment schemes and are less expensive to administer than relief at source, so a move to a flat rate of relief, which required the abandonment of net pay arrangements, would put under pressure the cost base of auto-enrolment schemes, which had previously used them.

57)

It would therefore be worth exploring whether there was a way for payroll and tax arrangements to retain an element of the net pay arrangement, while moving to a flat rate of ultimate tax relief. As member pension contributions under net pay are deducted by employers at the marginal rate, logic might suggest that a move to a flat rate would involve the tax charge (for higher and additional rate taxpayers) being subtracted from the pension contribution passed on by the employer to the pension provider, with the amount paid to HMRC by the employer instead. A higher-rate taxpayer, who had previously seen a reduction in take home pay of £60 for a £100 pre-tax deduction would still see the £60 reduction but only £93.33 would reach the provider (assuming a flat rate based on £2 of contribution receiving £1 of relief). That in turn would raise the issues of the addition to be applied to the pension contribution for basic rate and nontaxpayers where the net pay arrangement applied, the timing of tax relief for those taxpayers and the identification of the tax treatment for different members where HMRC, we assume, would need to reconcile matters. Clearly, further detailed analysis and an exploration of the full range of options is appropriate.

58)

On the other hand, if all schemes had to move to relief at source, given the expectation that individuals could on average have up to 11 employments and potentially be enrolled into 11 schemes in a working lifetime, moving all schemes to relief at source would bring clear benefits for the individual’s understanding when moving from scheme to scheme. There would be immediate costs arising from the need to make payroll system changes and set up the claim process needed to operate relief at source but there would be other clear benefits of achieving desirable consistency. Removing the offset against tax liability in payroll would also mean that all ‘relief’ allowed for the individual is paid into a pension and a similar result comes from removing claims under self-assessment for higher earners. This would result in more paid into a pension and all other things being equal, better final outcomes for individuals.

59)

As discussed earlier, flat rate relief would cause significant difficulties for defined benefit schemes and HMRC would need to have the resources to handle more relief at source claims.

60)

We hope it is clear that the introduction of a flat rate of relief would not be the straightforward option it is sometimes portrayed as.

Salary sacrifice 61)

We welcome the statement in the Budget 2016 (confirmed in the recent relevant HMRC consultation) that employer pension contributions would be excluded from the planned reforms to the tax and NICs treatment of salary sacrifice arrangements

62)

Salary sacrifice is sometimes perceived as a National Insurance avoidance device for the better off, but it is, in fact, a feature of many schemes used for auto-enrolment, and encourages remaining enrolled, either by facilitating better than minimum employee contributions across the entire workforce or producing higher take home pay. The percentage benefit is also largely greater for basic rate taxpayers than for higher and additional rate taxpayers. Consequently, any restriction or removal of salary sacrifice could make remaining auto-enrolled less attractive for employees, creating an incentive to opt out. Even if an employee did not opt out, the restriction or removal of salary sacrifice would be a threat to the success of auto-enrolment if it resulted in lower upfront contributions into retirement savings pots and therefore smaller pots to benefit from cumulative investment growth.

63)

There would also be a problem with distinguishing between genuine non-contributory pension arrangements and situations where negotiations between employee and employer have resulted in a mutually convenient package where pension is a feature in return for less pay and the sacrifice is “undercover”. Furthermore, it would be perceived as unfair to penalise one form of employer contribution but not another. Two workers on the same pay and receiving the same employer contribution could face radically different tax treatments based on one being a sacrifice and the other not.

Pre-Autumn Statement 2016 Submission Page 8

64)

However, a flat rate of relief, for example one, which could be presented as 2-for-1, would make salary sacrifice unattractive to a basic rate tax payer. A basic rate taxpayer using salary sacrifice currently has an effective rate of tax relief of 32% (i.e., a 20% income tax saving plus 12% national insurance saving). This is less than the 33.33% rate which would apply under a 2-for-1 flat rate system.

The imposition of National Insurance Contributions (NICs) on employer contributions 65)

This would have the deterrent effect on pension saving already noted in respect of a TEE system, if members faced extra primary NICs because they were enrolled into a pension scheme. In addition the imposition of secondary NICs on employers would most likely cause employers to immediately review their budgets for pension contributions with a view to achieving at least cost neutrality (so reducing retirement saving) but in many cases going further and reducing pension provision to a minimum auto-enrolment level. Finally, the problems already noted about valuing defined benefit accrual would apply with full force.

NET PAY AND THE LOW PAID 66)

Auto-enrolment, which has resulted in many more lower paid individuals joining pension schemes, has highlighted that pension tax relief given through the net pay system does not automatically reach scheme members, who earn less than the income tax threshold.

67)

There are a number of possible responses to this situation, which we would be happy to discuss in more detail, if desired.

CONCLUSION 68)

We would be pleased to address in more detail any part of this submission.

69)

If we were designing a pension taxation system from scratch, aimed at providing clear and simple incentives to save more for retirement, we would probably not design the current system.

70)

However, we need to properly recognise that the starting point is in fact completely different. There are trillions of pounds of existing retirement savings, for which any major change to the pension taxation system could have seriously negative consequences.

71)

We also need to recognise that the foundation of workplace pension provision is now autoenrolment. This at root aims to capitalise on individuals’ general inertia regarding retirement savings rather than on incentivising them.

72)

Although far from complete, the auto-enrolment project commands a very broad consensus and appears to be succeeding. Any future tax relief changes must be based on a similar level of consensus if they are to be trusted for the long term.

73)

Above all, before deciding on any major change to the pension taxation system, particularly if it involved moving away from EET, the government must consult in detail on the specific challenges for auto-enrolment of the potential change.

October 7th 2016 JM/JB 4.4

APPENDIX POSSIBLE CHANGES TO THE PENSION TAXATION SYSTEM: MOVING TO TAXED, EXEMPT, EXEMPT (TEE) FROM EXEMPT, EXEMPT TAXED (EET) 1)

Given the state of the public finances, the government could be attracted by arguments for a move to TEE, since it would provide a context, within which to bring forward significant amounts of tax revenue.

2)

We are far from certain that the top-ups, replacing up-front tax relief, adequately compensate some pension members for the disincentive of reduced take home pay that TEE would cause. An additional drawback is the complete lack of certainty on whether retirement benefits would actually be tax-free when they came to be drawn.

3)

At decumulation the preference would certainly be to take the funds that are tax exempt in payment before any funds accumulated under the current tax regime, if these remained outside the new regime. This would have consequences for the future flow of tax revenues. Undoubtedly, bringing forward the timing of the tax due on “old regime” funds would have the added attraction of simplifying the treatment of retirement savings. But the fairness of what could easily be perceived as a raid on pension funds would be questionable, since not all funds would have been subject to tax and savers would lose the future investment growth on the amount recouped early.

4)

Retirement saving is a long term endeavour for all involved and the focus of any change must not be on the potential for short term benefit to the Treasury. Therefore, it is appropriate to consider the implications beyond the short to medium term of a move to a TEE system. The finances of future society may be at risk of instability if everybody over State pension age pays no current tax on their retirement savings, with the proportionately shrinking working population taking on an increasing taxation burden.

5)

There might be social implications of a perceived unfairness between generations of a smaller working population supporting a larger retired population. In that sense TEE would risk being unsustainable and might (a) transform into a TET regime or (b) see the reintroduction of meanstesting for State pensions and/or other benefits (a significant gain from the State pension reforms is the removal of means testing as a barrier to saving) or (c) lead to a wealth tax, which includes retirement income.

6)

Research has indicated that the timing of an incentive is important, so delivery of and promotion of tax exemption in the form of tax relief or as a bonus or reward at the point of saving would be a greater influence on behaviour than the more distant promise of exemption many years in the future. Experience has shown that promises which relate to the distant future cannot be relied on, as governments need to react to current and future circumstances.

7)

We suggest that a tax regime, which provides an immediate reward, rather than offers the distant prospect of a tax-free outcome, is much more likely to provide an effective incentive for retirement saving. This would suggest that, for example, a matching approach, which re-labels tax relief to something simpler, would have more impact, in particular together with a more generous approach for basic rate tax payers. Compared to such a rebranded re-launch of tax relief, it is unclear that TEE would incentivise the majority of savers who ‘could but don’t’ save for retirement.

8)

Any change to tax relief is also an opportunity to build trust in the pension brand. A significant aspect of this would not be in the mechanics but in the communication of it. For example, at present relief is more a retrospective reward than a clearly understood incentive. In any reincarnation it needs to be turned into something perceived as an incentive.

9)

We have suggested that one of the highest priorities must be to ensure that any changes to the system do not undermine auto-enrolment.

10)

A move to TEE would certainly represent a threat to auto-enrolment because we would expect more people to opt-out in response to the reduction in take-home pay, which it would involve for scheme members in net pay schemes.

  Appendix Page 2  

11)

If any government top-ups under TEE failed to completely compensate for the lack of upfront tax relief, the outcome would be, all other things being equal, smaller pension pots to benefit from tax-advantaged accumulation and therefore poorer member outcomes. This would further damage the brand of auto-enrolment.

12)

The introduction of TEE would also raise enormous transitional issues concerning the treatment of pots already accumulated and it would require the maintenance of a different tax system for defined benefit provision, since, as we have already indicated, TEE and defined benefits are incompatible.

13)

In respect of defined contribution pots already accumulated, we assume that the government would not go so far as seeking to tax existing retirement savings at the date of change, thereby moving them onto a TEE system overnight. However, savers might be offered the option to switch from EET to TEE by transferring and paying an immediate tax charge on the amount. This would raise the possibility of savers making ill informed choices, which they might subsequently regret (particularly low earners whose personal allowances may mean they would pay no tax on receipt of their existing EET retirement savings). Alternatively, a TEE system could be introduced solely for future contributions leaving existing EET savings unchanged – which would add further complexity to the system.

14)

As we have already indicated, a theoretical attraction of TEE is that, notwithstanding the upfront additional cost of retirement saving, emerging benefits would be tax free. However, we again question how great an incentive this would be in practice. It would require a huge, and in our view improbable, leap of faith on the part of savers that as far as 40-50 years into the future the bargain of a possible definite reduction in take-home pay now, in return for a promise of tax free income in retirement, would be kept. There is no credible basis for assuming that 40 or 50 years hence the government of the day or society as a whole will accept that almost everybody over State pension age will pay no tax on their income and/or saving pots and will receive State pensions, State support with social care and free NHS care.

15)

Those expecting to be the beneficiary of the bargain could well face (a) taxation of income, which they had been assured 40 or 50 years previously would be tax free or (b) means testing of State pensions and/or benefits, on account of the tax free retirement income or (c) some form of wealth tax, which included retirement income. Whichever way, TEE would effectively have become TET.

16)

A TEE system would also increase the temptation under the Freedom and Choice flexibilities to take entire retirement pots tax free in one lump sum and possibly then spend it too quickly, leaving people to fall back on State support.

17)

The disincentive effect of TEE would be even greater as employer contributions became taxable as a benefit to the employee. We are aware of cases where employees have opted out of employer-funded private medical insurance because they did not wish to meet the tax charges, to which the employer contribution would give rise.

18)

In addition, treating employer pension contributions as taxable income could also impact on means tested welfare benefits and the amount of student debt repayments – resulting in bad publicity for retirement savings. The addition of employer contributions to taxable earnings would also mean that some employees move into higher tax brackets as a result of "earnings" they do not immediately receive

19)

In any event, it is hard to justify employees being taxed up-front on an employer contribution for a pension benefit they may never receive; indeed, as employer pension contributions are deferred pay, they should only be taxed when actually received as pension income. Were employer contributions to nevertheless form part of an employee’s taxable income when paid, individuals would often prefer to instead receive the amount as extra taxable salary, leaving them to decide whether or not to then make additional pension savings themselves. Inevitably, this would be likely to lead to less retirement savings.

  October 7th 2016 JM/JB 4.4