Henry Tapper says we need to take a wider view of pension taxation reform
We are used to thinking about pensions parochially, worrying about our patch and disregarding the bigger picture. If George Osborne conducts a tax-raid on pensions on 16 March, we need to see his behaviour in a wider context.
Close inspection of the government's figures tells us that the vast majority of tax-relief being used to incentivise saving is spent on people in occupational pension schemes.
The total annual value of income tax relief rose last year to around £35bn. Even when you discount the £14bn recouped from pensioners, there is still £21bn being used purely as a savings incentive.
If you consider tax-relief to be a way to encourage the needy to be self -sufficient in retirement, such a state of affairs is unsatisfactory.
More than half (59%) of this tax relief is estimated to have gone to those with incomes in excess of £45,000 pa. Pension tax relief is benefiting those with high incomes; even more pertinently, it's benefiting those who already have big pensions. This is because about half of that £35bn was paid against contributions made by employers into defined benefit schemes.
If you consider tax relief to be a way to encourage the needy to be self-sufficient in retirement, such a state of affairs is unsatisfactory.
Since the vast majority of DB accrual is in the public sector, it's logical for a Chancellor dedicated to deficit reduction to fix his sights on employer contributions into occupational schemes. Logically he should be focusing on the public sector pension schemes, which are funded directly by government and indirectly through tax-relief.
The deal done with the public sector and its unions has future proofed contributions and benefits till 2024. But these protections do not include changes to tax relief.
So the opportunity exists for the Chancellor to tackle the £17bn+ he's missing out on, when public sector employees fund pensions (rather than paying salary). He may consider this his only chance to control spending on public sector pensions.
What the Chancellor needs is a means to tax all pension contributions. Indeed, the Chancellor may be feeling he needs to abolish pension tax relief altogether.
What is truly scary is the Treasury already has the means to scrap tax relief. The ‘means' is called 'Scheme Pays' and is a system of collecting tax. It is currently used to help employees exceeding the annual allowance. Were the annual allowance switched to zero, it could be extended to cover us all.
How Scheme Pays works
The scheme calculates the tax due and pays it to the Inland Revenue. The payment is set against the member's eventual benefits, either by a deduction from the defined contribution pot or as an earmarked deduction from the promised guaranteed pension.
It offers a cash-strapped Chancellor the opportunity to get the Treasury round its two principal implementation issues.
Firstly, it takes the strain off payroll. The administration of Scheme Pays falls to the scheme not PAYE. If payroll is no problem, changes can be made quickly
Secondly, it allows all pensions contributions to be treated as a benefit in kind –without affecting take home pay. If people feel no pressure from the pay-packet, back bench opposition should dissipate. Just as Scheme Pays provides a golden key to implementation, so it tackles the wider issues relating to pension reward.
On the downside, the taxation of the employer's contribution presents valuation problems that would need to be addressed by enhanced GAD conversion factors. It will also need some extra administration for schemes but these are hardly insuperable obstacles.
Scheme Pays opens doors to a holistic approach to pension taxation that closes doors on abuse. Taxing employer and employee contributions as one benefit in kind reduces the advantage of swapping salary for pensions. Making pension contributions subject to national insurance would fully close the door.
There is potential to radically reform the tax treatment of pensions. The impact of abolishing tax relief is to immediately free up £35bn of revenues to plug the deficit and to target savings incentives on those most needing help.
Henry Tapper is a director at First Actuarial
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