The Prime Minister focused on the long-term nature of the 2015 Budget in a recent piece he published in the Sunday Times. He saw the Budget as “rewarding those who work hard and do the right thing. For too long, those who did the right thing were punished. Savers got penalised for saving”. He seems to have missed the reduction in the Lifetime Allowance (“LA”) for the second Budget in succession and the third time in four years. The cut in the LA has coincided with falling bond yields and a corresponding diminution of annuity rates, compounding the effect of the smaller LA. Those who have done the right thing by saving into their defined contribution pension continue to be punished – if anything, even more so.
The reduction in the LA was explained in the Budget (at paragraph 1.232) as being necessary to protect public finances from the growing cost of Income Tax relief for pension saving, with around two-thirds of this cost apparently going to higher or additional rate taxpayers. This relief was quoted as ‘costing’ Government £34.3 billion in 2013-14, up from £30.8 billion in 2009-10. It was not mentioned that the relief was £30.8 billion in 2007-8. It would also be more meaningful, to my mind, to look at the net impact of pension policy rather than just the relief side.
Contributions into pension arrangements are made gross of tax and accumulate free of tax too – the two sources of the costs previously mentioned. However, once these accumulated amounts are paid to the recipients, the receipts are taxed as income. Government effectively invests for the long-term, both in the financial security of its citizens and in recovering the tax previously deferred. Tax receipts on pension payments rose from £9.3 billion in 2007-8, to £10.7 billion in 2009-10 and £13.1 billion in 2013-14. The rate of growth on tax receipts significantly outstripped that of costs over the corresponding period.
The balance between tax earned on pensions in payment and tax deferred, rather than lost, on contributions and accumulation depends on the age distribution of the saving population. An ageing population of savers will likely see an increasing amount of tax paid relative to that deferred, as savings are converted into income. This swing towards a relative increase in tax paid was the path the UK was on prior to the introduction of Automatic Enrolment (“AE”). AE has resulted in a reversal of the decline of the number of (pension) savers. The ‘shock’ to the ratio of those drawing an income relative to those still saving is a one-off event and the increase in this ratio will likely resume once the initial roll-out of AE has been completed in 2018. The ratio will only reverse thereafter if there is a change in the country’s demographics and the birth rate picks up again.
The impact of AE might not be as significant as anticipated as far as tax relief on contributions are concerned. Over half of the tax relief is claimed by Employers. Corporation Tax will be levied at 20% from 2015/16, in line with an individual’s Basic Rate Tax. Some retirees will have tax rates higher than Basic Rate Tax so deferral will result in a higher rate of tax being paid on the related pension contributions made by Employers, whether these are ‘true’ Employer contributions or Employee contributions made via salary sacrifice. The retirees paying tax at a rate above the Basic Rate are more likely to be affected by the reduction to the LA, so cutting the LA will likely deprive Government of this tax uplift in the long-term.
The repeated cuts to the LA contrast with the treatment ISAs have enjoyed under this Government. Annual savings limits have been increased by around 50% over the past five years. ISAs have been made more attractive in other ways too. ISAs result in a more immediate tax take than pensions, being funded from after-tax money – consistent with a shorter-term view.
The pension freedoms announced in the 2014 Budget are also consistent with a shorter-term view. The Government anticipates the freedoms will be of net benefit to the Exchequer as long-term income is converted into short-term windfall, if not necessarily Italian sports cars.
The Government might well have adopted a long-term approach to managing the economy in many areas but I do not think this is the case when it comes to defined contribution pensions. Auto Enrolment is being successfully rolled out but that programme pre-dates the current Government. The changes made since 2010 have given savers more freedom (to pay tax) in the short-term but have penalised long-term saving in capital terms and even more so in income terms. The raft of changes over the past two Budgets have also increased the uncertainty related to pension saving. What will it take to get Government to take a long-term view of provision for later life, with corresponding incentives and regulatory stability?