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.
Henry There are many problems with TEE but the one which matters most is the credibility of the pension income remaining tax free. This extends also to the N in Michael Johnson’s enhancement.
Personally I would keep my savings offshore and a bag packed and ready under TEE
Henry I don’t agree with some of your premises, although it will not surprise me in the least when and if George blows another hole in convention. Whilst you make some very fair points about the financial services industry being prepared to change things when the changes benefit them, they have also had to put up with a very large amount of interference and intervention from legislation which has not benefited them in any way. The cost in time, money and other innovation caused by a major radical change is very, very high. Paying for several different pots all treated differently under different regimes is a potential nightmare, and very hard to understand for the pensioner who owns two or three different pots. You can’t justifiably sweep that issue away with a throwaway comment about the objections of the industry being piffle.
Whilst I think you have accurately described George Osborne’s attitude towards anyone at all who disagrees with him, I think it is rather early to assume that auto enrolment has been a success. Paying in 0.8% of your salary is not going to be noticed by most employees, no matter how highly or lowly paid they are. However, it will be interesting to see how many people already enrolled stop their contributions when it gets to 5% gross – which is what they will be paying if the TEE or TEEN systems are enacted by then. If a sizeable number of employees withdraw from automatic enrolment before contributions become meaningful then it really won’t have been a success.
As regards your conclusions, I agree with conclusions 1. and 2.
But conclusion 3. is based on very flimsy evidence. Given that tax relief is not noticeable at a rate of 0.2% of salary of course it won’t be an incentive to low earners at the moment. But from a personal point of view most of my clients only contribute to pensions because of the tax relief. Whilst a lot of them would and do save in other forms of saving there is no doubt that they are motivated to save more by the existence of tax relief.
Point 4. to me is just not right. If people are only going to get an incentive if they behave properly what right-minded person would sign up for that kind of system? That is no incentive at all, it is a flimsy suggestion of an offer of a possibility of an enhancement. The point of sale is NOT at retirement it is NOW. The government can simply change their minds and not give an incentive for behaviour that was previously acceptable under a different regime the next time they need to save more money. Pension Wise is brilliant in principle but in practice it matters not a jot whether someone with a £20,000 pot buys an annuity, draws £1,200 per year or buys a Ford Focus ST with alloys. We need people NOW to save MORE. We need people to save enough so that they have a real choice with their retirement pot, a choice that makes a real difference to their lives. I don’t think this debate is just about fiscal policy it is about far more than that. It is about what we as a society want for our futures. Radically overhauling the system on the basis of such flimsy arguments is a disastrous course to pursue. People who earn so little money that they do not pay tax are up the creek without a paddle regardless of the system used. They will always need assistance from the state if they never get to earn enough to pay taxes. I am happy to pay my taxes to support such people. And I totally agree with needing more money to sort out the NHS, but don’t nick it from the pot which provides tax relief which helps incentivise people to eat well and heat their homes when they retire.
Henry,
I agree with much of your analysis but I come to a different conclusion.
I believe that we should be attempting to help as many as possible obtain an adequate retirement income. If we go to TEE basically auto-enrolment will fall back to 7% of earnings. Some state that this should be closer to 15% to achieve an adequate retirement income.
However if we go down that route and begin to take 8% plus from employees pay packets for auto-enrolment contribution opt-out rates will increase and the initial success of auto-enrolment will be lost.
If the government matched contributions paid with its own contribution, auto-enrolment contributions become 14% of band earnings. To cap cost to government a lifetime allowance on pension contributions would be introduced of say £300,000.
By increasing amounts that can be subscribed to ISAs an EET system would be available once the £300,000 contribution limit had been reached.
Such a system would encourage individuals to build the necessary 2nd tier income for retirement, but not excessive amounts, reduce demands on welfare, reduce liabilities for public sector pensions as the system can apply equally to DB, yet facilitate tax exempt savings beyond pensions for the more wealthy.
Those who favour TEE often quote the success of ISAs. I do not believe ISAs are a success from a long term savings point of view. Only 12.6% of households hold money in a stocks and share ISA compared with the 42.8% who hold a cash ISA. Last tax year more than 80% of ISA subscriptions went into cash. With the first £1,000 of interest being tax free from next April it will be interesting to see how much of the ISA money in cash stays in its current home.
I have been asking myself why I am uneasy about TEE. Especially when in the 1970’s my mentor often talked of it as the way forward.
I have concluded that my uneasiness comes from a lack of knowledge as to how it would work. My mentor could stand scrutiny because he could detail the practicalities of his thoughts. All we have to date is a few high level words from the Chancellor and others banding the message with little detail.
In the interests of stimulating debate I raise some issues that I feel need to be addressed to win me over.
1. Employer tax relief – This is the biggest beneficiary of the EET system. It comes from the fact the cost of employee remuneration packages, is an expense of trade and can be offset against Corporation Tax. Therefore some form of EET will remain unless Employer Contributions are barred.
2. Benefits in kind – tax. Under our EET system employees are not taxed on their employer contributions to their pension. Presumably under a TEE system, for every £10 employer contribution a basic rate tax payer would have to pay £2 income tax. Otherwise we are just tweaking the EET system
3. Benefits in kind – NI . Following in from 2 both employer and employee receive NI relief on the employer contribution. Under the EET system I presume this will go and although employers will receive corporation tax relief they have to pay NI as if the contribution was a salary payment. Therefore despite receiving 20% corporation tax relief they will have to offset this with a 13.8% NI contribution. Similarly the employee will have to pay NI contributions on the employer contribution, a further 12%. Again I presume that TEE NI rules would have to be aligned with pension benefit in kind rules.
I like incentives to encourage more pension savings, particularly £1 for £1 matching. The “sale” to the employee is that for an 80p net pension contribution £2 is invested in your pension. Net cost to employer is also 80p. If my understanding of a TEE system is as above this means the net cost to the employee would become £1.32 and to the employer 93.8p.
I have two problems with this. It is a much harder sale to employees to overcome £1 costing £1.32. What is the selling point to employers when the combined cost of £2 in an employee’s pension fund costs more than £2.25?
How will EET work in practice?
Re: “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.”
I disagree. This is COMPLETELY ass about face.
With EET the ‘incentive’ (the initial E) is gradual and over a lifetime. A steady payday by payday drip drip drip of ‘look what you just got (or might be missing)’. A move to TEE shifts all the incentive out to one isolated event, eventual retirement. At that point it is entirely too late to look at this and feel anything other than cheated. Regular small inducements are much, MUCH more powerful than one later and larger one. TEEN does nothing to solve this.
EET has worked well in Britain for nearly a century. In contrast, neither TEE nor TEEN are sensible. A chancellor with any common sense and an understanding of behavioural economics would reject both in favour of the EET status quo. It is an open question as to whether or not we have such a chancellor (in my view, we do not).