“We all defer together?” – Guest Blog from Ralph Frank

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The recently announced consultation on pensions tax relief has stirred up thought and debate on the issue of incentivising long-term saving.  There are theoretical, commercial and practical aspects to be addressed in this process of defining an approach to pensions tax relief for the future.  A clear and consistent theoretical basis does, arguably, make it easier to begin to build a robust approach for implementation.

There is widespread acknowledgement that immediate consumption is preferred to deferred consumption.  This short-termism generally holds even in the face of an understanding that setting some reserves aside for periods when consumption exceeds income (e.g. retirement, unemployment, sickness etc.) is prudent.  Governments around the world have sought to address this short-termism, and encourage private provision for retirement, by providing tax incentives for savers to defer their income/consumption.  These incentives have related, to varying degrees and in different combinations, to: tax relief on contributions; favourable treatment of gains while invested; and tax breaks on benefits at/in retirement.  The general theme has been a deferral of income/consumption by the individual in exchange for a deferral of taxation by the government.

It is challenging, if not almost impossible, to achieve parity in this deferral between the individual and the state primarily as tax regimes and rates change over the course of the deferral period. The principle of mutual deferral has been sufficient to satisfy most governments.  The consultation floats the idea that that “pension contributions are taxed upfront (a “Taxed-Exempt-Exempt” system like ISAs)”.  Would it not be inconsistent of the Government to take its tax immediately while expecting its citizens not to be able to have corresponding access to their remaining income?  Granting equivalent access would then turn long-term savings into on-demand savings, albeit within a tax-exempt accumulation vehicle, likely accompanied by the issue of immediate consumption.  The experience of 401(k) savings in the United States, where pre-retirement access is permitted, is a useful guide – if one is needed.  Initial experience of the pension freedoms in the UK suggests a similar outcome (of short-termism) too.

It would be helpful to all concerned if the Government clearly set out its objectives and philosophical beliefs in undertaking the consultation.  Some principles are mentioned in the consultation document but do seem to contradict prior statements and/or actions.  Specifically, what balance is sought between:

  • Incentivising more people to make sufficient (private) retirement provision and the cost of this incentivisation. The Government’s over-riding concern, expressed in the 2015 Budget too, seems to be the quantum of tax-relief accruing to private pension provision;
  • Encouraging people to work hard and do the right thing, as the Prime Minister sought to do after the 2015 Budget, thus taking personal responsibility while then seeking to limit this encouragement (by reducing the Lifetime Allowance (“LA”)). The revised LA from April 2016 does not even support a guaranteed income in retirement, with provision for a spouse, at a level equal to National Average Earnings let alone provide incentive to strive for more;  and
  • Creating a simple and transparent system while seeking to manage the distribution of tax relief across tax payers. Tax relief is becoming increasingly complex, as most recently highlighted by the introduction of the tapered reduction of the Annual Allowance.

Automatic Enrolment (“AE”) has succeeded in reversing the decline of the number of savers making private provision for their retirement.  The number of savers making private provision will continue to increase as AE reaches its steady state by 2018, when all employers will have to provide pension arrangements to eligible employees.  The contributions that these savers make will increase over time, reaching 8% of qualifying earnings by October 2018.  This consultation has caused some uncertainty, having been announced as AE continues to gather momentum.  The Government’s ‘contribution’ via the tax break savers receive on their contributions is a driver of the momentum.

The consultation creates the opportunity for meaningful long-term improvements to be made to the system of tax relief and incentivisation for long-term saving.  Is the Government prepared to continue to defer alongside those saving or are we all in….?

Ralph

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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