There are two ways to get money into a private pension
- you can pay the money in yourself as a deduction from pay
- you can have money paid on your behalf by your employer.
Of the two, by far the more efficient is the second as employer contributions to pensions attract no national insurance, can be relieved against corporation tax and are not considered as pay – so not taxed as a pay-like benefit ( a benefit in kind).
George Osborne’s pension problem is that if he does away with tax relief on people’s private contributions, he simply increases the motivation for people to get their employers to pay on their behalf.
Many people (including myself) pay no pension contributions but have a big chunk of money paid into their pension by their employer. I chose to exchange salary for pension , some just get a handsome pension contribution by right.
Of all those who get pensions by right, it is Government employees who get the most. The real cost to the Treasury (and thus to the taxpayer) of paying public sector pensions varies (depending on the efficiency of the scheme and the generosity of the contribution but is typically about 15% of a Government worker’s salary.
Why a simple flat rate is no rabbit!
According to official figures, 90% of the tax lost through tax-free pensions is lost to 10% of the population – the richest 10%.
So the pension system is rewarding the rich and public sector employees disproportionately. Any change in taxation which focussed on restricting abolishing tax-relief on contributions made by someone on their own behalf, would hurt the self-employed and those who cannot flex pay and pension through salary sacrifice (typically those on low incomes and with small firms with limited pension expertise.
Those who argue for a flat rate tax-relief system on personal contributions know this full well. If we simply chose to tax personal contributions, there would be a wholesale migration to salary sacrifice, a bonanza for pay and reward consultants and a disaster for those without access to advice or the comfort of PAYE.
ISA – the Treasury’s rabbit
The Financial Times is running an article this weekend written by Jo Cumbo that suggests that the Treasury are aware of the weakness of a flat-rate personal tax but scared of abolishing tax-breaks on personal contributions altogether.
The only ways they have to recoup lost tax would be to
- tax people on any contribution made to their pot ((notional for DB, nominal for DC))
- tax the pension contribution itself
Option 2 is the one Jo suggests is favoured. This would – for all employers committed to picking up the balance of cost on a DB plan, be a simple tax on company profits. To meet the financial obligation, companies would have to pay higher pension contributions, loaded by whatever the tax rake-off was set at. I don’t get how this meets any of the Treasury’s aims for corporate taxation. However I see it as a stealth tax that will keep people happy for now (and like back-end loaded personal pensions), will cause the damage later.
Will Osborne be seen as the Chancellor who scrapped one set of exit penalties so he could impose his own?
Option 1 seems feasible. We already have an annual allowance which tapers between £40,000 for lower earners down to just £10,000 pa for those with super high incomes. Those with super-high incomes are already in danger of being taxed at punitive rates on large employer contributions. Many are pulling up the drawbridge and choosing to take salary rather than pensions ( pension sacrifice).
I don’t think the Treasury would consider losing the highly pensioned from future pension accrual a disaster. They have plenty of other reasons to vote for him
It is only a simple step from a £40,000 annual allowance to a pension allowance. like the current ISA allowance That lower allowance could be a flat rate pension allowance as we have with ISAs. Contributions within this allowance would continue to enjoy tax privileges, but contributions above that amount would not.
If I was Osborne, I would be peddling the language of ISAs hard in March, they are the only tax incentivised savings people understand. If people think they are getting pension ISAs -he stands a chance of winning popular support.
Expect the un “X” pected
Ken Davy has warned advisers to expect from the Treasury, a solution that could be as radical as pension freedoms. There are plenty of odd-shaped rabbits that the Treasury could pull out of the hat.
One such rabbit is the capacity of the Treasury to reduce still further the lifetime allowance, which is a cap on the size of pot (notional for DB, nominal for DC).
But for all this to work- (e.g. go down well with today’s tax-payers, create a lasting political settlement and satisfy the Treasury), there is going to have to be a stroke of genius.
This pension reform is going to have to have the X-factor- as pension freedoms did. There is going to have to be a golden key in the marketing of all this which makes the reforms seem fair, reasonable and workable.
Reading the FT article, I did not sense the golden key has been found yet. But I suspect that after years of trying, the Treasury is close to finding a golden mien that will dis-satisfy everyone equally.
The Y factor
If we can have an X-factor, why not a Y factor? The X factor is a settlement which works in 2016 and the Y factor is one that works in 2019, by which time the 12m people who have started saving through the workplace see their payments increase from 1 to 5% of the pension band.
For someone of average earnings, that is an increase from £200 to £1000, it’s a loss of tax to the treasury growing from £40 to £200 and if you multiply the difference (160) by 12m you get an idea of the tax hit from full auto-enrolment at current opt out rates. Anyone advocating an increase in the flat rate (whether to 25% or as much as 33%) must reckon on the cost of auto-enrolment to the Treasury increasing by between 20% and 65%.
Personally I am in favour of maintaining or even increasing the Government Incentive to those who are and will enroll. A genuine incentive to stay in and a meaningful contribution to the small pots of the least pensioned meets my idea of social purpose.
But I cannot see the rabbit from the hat allowing incentives to increase for the have-nots without attacking the rights of the “haves”.