I was re-reading Steve Webb’s article in the Daily Telegraph where he outlines why he thinks Pensions ISAs would be a disaster. The more I read it, the less I get it.
Let’s go back to basics. It is generally considered a good thing to have a strong first pillar of pension savings paid for out of general taxation and providing a safety net for the poorest and a platform for the rest of us.
It is also considered a good thing to have a second pillar of savings, typically called workplace pensions where people’s basic state pension is supplemented. Typically employers and employees have shared the risk and Government has incentivised this with tax relief.
There are other things that people can do to give themselves security in retirement (the third pillar- such as buy-to-let, entrepreneurial business activity etc, We can call this the third pillar- I think these pillars are the idea of the OECD (but Con Keating will probably correct me on this!)
Three pension pillars (of wisdom)
So we have three pillars, of which the second is the one under consideration today. I learned from my friend Ben Juppe some twenty years ago that the Government has no business interfering in how people save other than to ensure that people do not leave themselves a burden on others by not saving.
If there is an argument for compulsion it is that “reasonable force” can be applied in the public good – but only as a last resort. Throughout the 90s and noughties, we struggled with the idea of a compulsory state pillar and rejected it in favour of auto-enrolment. If that didn’t work – we told ourselves- we could make pensions compulsory.
In a great book called “Savings Sense” (commissioned by Steve Bee when he was at the Prudential, Ben Juppe concluded that tax relief was an incentive to save for those who paid tax (especially those who paid a lot of tax) but a rubbish incentive for those who paid not tax.
The Government ignored Ben and part of the Stakeholder Pension “revolution” that so conspicuously failed, was the granting of tax relief to those who didn’t pay tax. The Relief at Source taxation system did not increase take up from those who paid no tax, it was used by savvy taxpayers to provide pensions for their non-taxpaying children/grandchildren.
So Ben was proved right, tax relief does not incentivise those who pay no tax because for them tax relief is so abstract a notion that they fail to engage with it and anyway, they feel they have no means to save.
Auto-enrolment succeeded where tax-incentives failed
Auto-enrolment has proved to be a much more successful strategy as it shows that those who feel they have no means to save, find themselves saving despite themselves. Like the reluctant swimmer, standing on the edge of the pool, they find the water quite nice, once they have been nudged in. As with people who claim they “don’t have time” most of us who claim we have no means to save actually mean we have no “will to save”.
Now we have pretty near universal coverage through auto-enrolment, almost everyone will be saving – though between 8-28% of us may opt-out (the higher number being the DWP’s current worst case scenario).
With such high savings rates, the need to provide tax relief diminishes, especially for those who don’t engage with tax and don’t understand how tax relief works or benefits them.
Osborne can’t afford EET and auto-enrolment
As has been demonstrated by the numbers released in the autumn statement, the extra cost of giving tax-relief to a whole bunch of people auto-enrolled into 4+3+1 pensions from 2016 is £840m for 6 months or £1,680,000,000 for a year. That is a lot of extra money for the Chancellor to find, especially as it increases in line with the AE thresholds (earnings).
Any Chancellor lying awake at night could reasonably consider that with auto-enrolment, the job is done. There has been no compulsion, there has been maximum inclusion and the need to fund the tax relief is minimal.
Not only this, but the people who are doing all the moaning about moving away from TEE are the people with the big fat pension pots in the first place. Why should George Osborne continue to supplement the pensions of the people way over the destitution levels that might make them a burden on others? Hasn’t he got better things to spend his money on- like propping up the creaking NHS which is gong to have to take the strain of all of us living a lot longer?
Special pleading from the financial service industry will fall on deaf ears
The big losers from a move from EET to TEE are those who manage the wealth of the wealthy – and the wealthy. Osborne has shown no worry hacking off the wealthy- he’s doing it by smashing up the offshore tax shelters and by laying into buy to let. He is quite capable of smashing up EET in the same way so that people will get tax exempt savings rather than tax-exempt contributions.
This may not be what the Pensions industry wants to hear, but I don’t think that George Osborne is particularly worried about that either. He is a very radical Chancellor with no interest in being loved by the financial services lobby.
Teen– age kickers
Steve Webb’s final point is about the behaviour of those of us receiving our retirement pot tax-exempt. He points out that currently only a muppet would blow their savings on a Lamborghini and be left pawning the Lamborghini to pay the resulting tax bill. He isn’t quite right here, a lot of people who aren’t muppets have taken their money early and paid the bill- one of my best university friends is currently cruising the world on his pension savings, he having a life expectancy of less than two years having been diagnosed with terminal cancer in his early fifties. There are many with similar stories,
But leaving this aside, it is true that paying tax is a disincentive to blowing the cash at once, especially where you can take much of your money with little tax to pay, if you take it in stages.
Michael Johnson tells me that the best argument to encourage good behaviours (eg not to blow it all at once) is to incentivise behaviours at retirement. He advocates TEEN, where the EN stands for “enhanced”. In other words, you get a “Georgie bonus” for spending your retirement savings sensibly and don’t if you blow it. Obviously the bonus is paid for out of the tax savings from not giving you (and others) tax relief on contributions.
Four simple conclusions
This is all highly speculative, I have no idea what will happen in March 2016 – when we have our budget, but I am coming to these conclusions;
- It is auto-enrolment that is disrupting EET and forcing the Chancellor to radical measures
- Flat rate EET does nothing to help the Chancellor as most auto-enrolled would get more rather than less tax relief
- Most auto-enrolled aren’t incentivised by tax relief , they simply needed the “means to save”
- The best way of dealing with at retirement behaviours is to give incentives at the “point of sale” eg – when people are deciding what it means to be Pension Wise with their pot at retirement.
All of which leads me to consider EET totally unsuited to the new pensions world, TEE to be a much better option and TEEN to be the best option still.
As for all the special pleading about the complexity of transitional arrangements – this is piffle, the financial services industry has been happy to embrace change when it has been in their favour, this time they will have to stomach change even though it isn’t.