Pete has been with Scottish Widows for 29 years, holding a wide range of senior positions, including Head of Individual Pension Propositions and Head of New Business Development in Corporate pensions, before taking on the pensions policy agenda in his current role as Head of Pensions Policy.
One of the most hotly-debated topics in financial services is the future of pension tax relief in terms of what the future holds for the thresholds, allowances and the nature and purpose of the tax system itself. We’d like to take this opportunity to share some of our thoughts on this.
1. does the system achieve its purpose?
The purpose of tax relief is to compensate or reward people for locking their money away for a long period of time, so that they are better provisioned for their retirement. However, the system is poorly understood. Many savers are unaware of tax relief which diminishes its potential value as an incentive. Other savers who were aware of relief are surprised when they reach retirement and discover that tax is payable on pension income. ‘Relief’ might more accurately be relabelled as ‘deferment with a marginal element of relief’, although that would obviously do little to raise levels of awareness and engagement. The system also allocates the majority of relief to those who need little incentive to save, providing a valuable top up. It could be argued that those on lower incomes and in the greatest need of a top up, benefit least under the current system.
2. Before thinking about tax reform, we first need to think about pension reforM
- Auto enrolment has been a successful first step in the right direction but we still have a long way to go to construct a long term savings system which is fit for today and fit for tomorrow; the level of saving, even at 8% remains too low.
- Retirement planning is currently carried out using a myriad of products and fails to properly take account of the role of property, including renting in retirement and housing equity.
- Retirement saving is challenging for those who find it hard to make ends meet today and needs to be considered alongside the challenges of short term financial resilience and avoiding problem debt.
Auto enrolment has little appeal to five million self-employed workers, where different solutions may need to be found.
It would make sense to design a long term savings framework which is relevant to everyone and relevant to the times that we live in, and only at that point design a tax framework which complements that framework by incentivising and rewarding the right behaviours and the right people.
3. The current system is not financially sustainable and is geared towards benefiting higher-rate tax payers the most
The current system costs the taxpayer about £54 billion a year. Of that total, around £16 billion goes to employers, who do not have to pay national insurance on their contributions. The remainder is ‘relief’ provided on individual or employee contributions. It was designed to incentivise people to save and compensate them for locking away their savings until retirement. But at the moment, the biggest slice of tax relief goes to the highest earners.
It’s estimated that basic rate taxpayers receive only 30% of relief, despite making half of all contributions and constituting nearly 80% of taxpayers (source: RAS, Venturing to retire, 2018). Many higher-rate taxpayers will benefit from 40% tax relief on their contributions and will only pay tax of 20% on their pension income. In addition, 25% of most people’s pension savings can be paid to them tax-free. The complicated addition of the various allowances and tapering mean advice is essential for wealthier people who may be affected. The current system is overly complicated.
Relief across the nations of the UK could increasingly vary. Scotland, for example, has introduced different tax rates and bands and more complexity, especially for those on middle incomes. Individuals paying the new 21% tax (earnings between £24,944 and £43,430 in 2019/20) can claim an extra 1% of relief through their tax return. Similarly, individuals paying 41% income tax can claim an additional 21% through self-assessment. This could be particularly confusing for employers operating workplace pensions with business locations across the United Kingdom.
4. Which type of workplace scheme is right for your workforce?
From a taxation perspective, workplace pension schemes can operate in two ways;
Relief at source (RAS)
Here all employee contributions are made from net pay after tax has been deducted at each individual’s marginal rate. The pension provider will gross up all contributions by 20% and recover this from HMRC at a later date. Higher rate tax payers reclaim the additional 20% through self-assessment. Those on low incomes who pay no tax effectively receive a 20% bonus.
Despite its name, contributions here are made from gross pay before tax is deducted. All contributions are therefore made with relief already applying at the marginal rate applicable for each member. This means that higher rate tax payers do not need to recover the difference through self-assessment, but those on the lowest incomes lose out on the 20% bonus entirely.
Employers may wish to consider the profile of their workforce before determining which type of arrangement is most suitable for their workforce.
5. The uk’s pension assets could be a valuable national resource
We need to re-visit what the purpose of tax relief is and who is intended to benefit from it. The purpose of tax relief has traditionally been to compensate people for putting money away for a long period of time, deferring gratification which could have been realised today. However this is less true today, following pension freedoms which offer more immediate and more flexible access than in the past.
The Government could in the future take the view, that they will contribute towards pensions which sit within qualifying product types, where that qualification depends on a proportion of the assets being used in the national interest, for example infrastructure, social housing, patient capital to support business start-ups.
6. Moving to a flat-rate of tax relief is much more complex than we perhaps think
Whilst a flat-rate of tax relief appeals to many people, implementing this could be incredibly complex, either requiring payroll systems to be modified to calculate a ‘semi-gross’ employee contribution or extensive communication between employers, pension administrators and HMRC to reflect and under or over payments of relief in personal tax codes.
For employer use only.