The concept of “flat rate tax relief” for pensions is now accepted. There is a consensus behind it. Even the ABI, who until recently were predicting plagues of locusts if higher rate relief were abolished, appear to have got behind the flat rate.
The response of the pensions industry reminds me of the French strategy of building fortifications to defend against the Germans – in the wrong place!
I don’t want to characterise our Government as the “enemy”, though “change” is clearly an enemy for those who have the money and continue to benefit from the current system.
The analogy with the Maginot line holds. The French were outflanked by a nimbler opponent who used Blitzkrieg tactics to make the traditional fortifications of the line redundant. Infact the Maginot line became a liability as the French army found itself cut off from its lines of retreat.
As with Pension Freedoms, George Osborne may be outflanking the pensions industry by moving the cheese and preparing to adopt “Pensions Blitzkrieg”.
Flat rate tax-relief, where we all receive a financial benefit at an equal rate (per unit saved), would of course make saving into pensions less attractive to higher rate tax-payers (who can claim back up to 45% of their contributions at the moment). The flat rate would – at its highest- be set at 33% , the PPI have done calculations at 25% and Legal & General (who aren’t in the ABI) have called for a flat rate of 20%.
The PPI’s work was based on the world as it was in 2013, I suspect that others (including the Treasury) are more interested in the world in 2018. The £6bn a year that the PPI claim would be the net saving from a 25% flat rate may not materialise in 2018-19 (as I’ll explain in a moment.
The alternative is seen as moving to a system where tax relief is granted on pensions in payment (or even on the lump sum payment allowed by the pension freedoms). This is generally considered a “bad thing” even by the Pensions Minister as it’s seen to encourage over spending in retirement (and nobody trusts a future Government not to move to a system of taxed exempt taxed in the future).
I am moving to a view that the idea of TEE – the acronym for putting tax relief on the spending not saving, is politically unacceptable. But I suspect a Pensions Blitzkrieg, I think the Chancellor is preparing to abolish pensions “tax-relief” altogether.
If flat rate tax relief is the Maginot line, RTI is radar!
Of course I don’t think that pension saving won’t continue to be encouraged by the fiscal system, but the “yours by right” version of encouragement looks like going. Instead, I see a system of Government Incentives (“pension credits” as my friend Con Keating mischievously re-branded them) that can be used to target those groups of savers the Government wants to encourage.
The DWP already use this phrase to describe the 1% tax input to the 4+3+1 AE payment. Government Incentive not only sounds better for the Government, but it anticipates a world where the Government operates savings incentives independently of the tax bands.
Theoretically this is made possible by the digital revolution that has allowed HMRC to interact with employers using RTI (real time information). RTI is as important to the Treasury, as radar was to Fighter Command. It gives Government the information needed to react quickly to changes in economic circumstances.
It’s what is happening already under the relief at source arrangement – a system where those paying no tax, get a Government Incentive – rather than tax relief.
We can’t afford a flat rate- with auto-enrolment.
Pension saving had been in slow decline for a number of years till 2013. Over the last two years we have seen 5.7m new people saving for the future, more than even the Government expected. The success of auto-enrolment has made the potential strain on “tax-relief” enormous. When the majority of those 5.7m savers are joined with as many again (following the induction of 1.8m SMEs and Micros) there will be as many as 12m new savers by 2018.
In 2018-19, the cost of tax-relief, as we know it today, will go through the roof as these 12m workers increase their contributions from 1 to 5% of band earnings.
If a system of flat rate tax relief at say 30% was in place when this happened, the cost to the Treasury would increase from 20% + , by almost 50%. Whatever saving made by moving to a flat rate would be wiped out – and a whole raft of new cost brought to the system.
Small wonder that the pensions industry are happy to promote a flat rate.
We need a more flexible approach
If the Chancellor were to scrap, as I suspect he will, the concept of tax-relief, and move to a system of incentivised saving, he would get back the fiscal levers to manage the problem of auto-enrolment without risk to the nation’s finances.
It may well be that what we get on March 16th looks like flat rate tax-relief. But if the Chancellor is clever- and I think he is- he will not commit the country to a lasting fiscal settlement over which the Treasury can have little fundamental control.
By breaking the link with tax rates and moving from a system based on your marginal rate of tax, George Osborne has the chance to manage pensions on a dynamic rather than a reactive basis. With the wall of money arriving into pension savings in 2018-19, I cannot see he has any other option.
Now is the Chancellor’s time
He has the infrastructure in place-through RTI (his baby) to implement such a radical system. The move to digital self-assessment means that most higher rate tax payers are responsible for claiming their reliefs on line. The PAYE system can now manage change relatively easily (most pay systems now being digital – and the new ones cloud based).
Self assessment is now a social norm and we are increasingly seeing a move to people claiming entitlements for themselves. The default system for providing these incentives may move to “by claim” rather than “by pay-code adjustment”!
Osborne is showing himself ruthless in driving through change. If there is any doubt, we need only look at his approach to LGPS fund management. The Pension Freedom success will have given him any confidence he lacked.
I genuinely expect radical change- more radical than the Maginot line- as radical as radar was to defending Britain in the Battle of Britain.
The certainty of tax-relief is something that the pensions industry has relied on for 50 years. However it has become complacent with this system and has not made the most of the incentives given it.
A system for DC and DB
The Defined Benefit system is – sadly – a system in tatters. It’s only surviving bastions, the Governmental pensions (funded and unfunded). For contributions made by employees and the employer to be treated on the same basis as the Defined Contribution workplace pension is within the compass of this system of incentives,
Auto-enrolment is a game changer, and with it comes the opportunity for Osborne to sweep away the old and bring in the new. When nothing is ours by right, the opportunity to move the cheese can have extended benefits. I would be surprised if the fundamental apartheid between the “haves” (with ongoing accrual in a DB world) and the “have nots” with limited rights under DC – will continue.
It would not be hard- where tax relief (not to mention salary sacrifice) was no more -for all pension contributions from the employer to be considered a benefit in kind.
A system of incentives could cushion the blow, but the principle would have been established.
Winners and losers?
The pension industry would like us to believe it is prepared for change. I am not sure it has thought the unthinkable and I’m quite sure the Treasury has.
The ideas mooted in this article are not pension sci-fi. They are the kinds of ideas I’d be having if I was the Chancellor.
Not only that, but these ideas are rumoured to be doing the rounds- by authoritative sources.
I suspect that George Osborne will do everything he can to make it seem there are no losers -only winners- in his new world. But with so many new savers lined up for their share of the cake, and with such massive imbalances from the pension apartheid of DB/DC, I can see a lot of teeth gnashing from March 17th.