“I’m sure it’s in  there somewhere!”

Who pays? – Scheme Pays!

Buried deep in the technical pages of HMRC’s pension regulations is reference to a breezy topic “Scheme Pays“.

“Scheme Pays” allows an occupational pension scheme to pay a member’s tax bill where the member has triggered that bill by having too much paid into their pension pot.

This can quite easily happen when someone in a defined benefit scheme sees their pension jump year on year – perhaps because of a promotion – or simply because the member earns a lot and gets a decent pay rise. Technically it’s called breaching the Annual Allowance.

“Scheme Pays” is such a simple phrase that it seems harmless. But there is a cost. When people get to retirement, they find that what they would have got has been eaten into like a worm with an apple. When you get to retirement, you pay for what the Scheme Paid.

Scheme Pays rocks George Osborne’s boat.

Expect Scheme Pays to become a lot more important going forward. If, as I suspect the Treasury decide to treat contributions from employers as taxable as a benefit in kind, not just the few, but everyone who gets a contribution into a pension, will be incurring a liability to tax.

Imagine the outcry if this tax liability triggered every month in pay! People would see a fall in take home, payroll would be swamped with complaints and we’d have civil insurrection like we had with the poll tax riots.

But under “Scheme Pays“, things are a lot more easy. For DB schemes, the Government imposes a formula for valuing the employer contribution (a more sophisticated set of factors provided by GAD).

For Defined Contribution Schemes, the contributions are docked with the appropriate level of tax, before they are passed to the investment manager. This is how the T (in TEE) might work.

And we’ll all have choices!

People might have choices with regards taxes.

1. they might choose to pay their benefit in kind themselves – possibly through self-assessment as I doubt most payrolls will be able to manage this through PAYE
2. they might choose for the scheme to pay and pay now
3. they might choose for the scheme to pay and pay later (with the tax-bill ear-marked against the final benefit you get when you come to draw benefits.

I think I’d choose to pay my tax upfront as I would be fearful of how that tax liability might roll up between now and retirement. If I was a Chancellor wanting my money now, I’d make it clear that deferring the pain might not be in my best interest!

Could pension contributions be subject to National Insurance?

One thing that a lot of pension people have been using to get round the cost of paying people and then collecting pension contributions, is by asking members not to get paid their pension contributions and agree to have this money paid by the employer into the pension scheme.

Not only does this take out the need for tax-reclaims, but it saves on national insurance paid by employer and employee.

I suspect that a brutal Treasury has had enough of this kind of thing. Welfare is enough of a headache to Government as it is, reducing the means to pay welfare bills by allowing people to duck the welfare tax (well that’s what National Insurance is), is a blow to the Treasury’s sola plexus.

I am beginning to smell a move to make pension contributions, whoever makes them, subject to national insurance, if they are a benefit in kind, they kind of look like pay! (incidentally the argument that pension contributions are deferred pay is one that many HR and reward managers quite like!).

So why’s the Treasury going this way?

1. It is simple enough for most people to understand
2. It allows people to tax and not to suffer (pay packets won’t go down)
3. It enables Osbourne to tax the public sector and to tax DB accrual and DC contributions equally
4. It makes the Treasury a huge amount of money (most of which they can collect up front)
5. Increases in national insurance can be justified as supporting Welfare.
6. On money that isn’t collected up front, the Treasury can impose a fearful tax roll-up (say 3% pa)
7. It is all relatively easy (and quick) to implement, since payroll don’t need to get that involved.
8. It is very hard to get out of paying tax on your pension contribution

Effectively it puts the Treasury in control of what’s left of the word “Pension”.

So who will feel the better for this?

1. The first and predominate beneficiary is the public exchequer which is able to bring forward a lot of future tax receipts so that books can be balanced by 2020
2. By 2020, George Osborne can present himself as a credible candidate to be our next prime minister
3. Not all the money saved by the “T”need be lost. There will be plenty in the kitty to pay a little E.
4. The pension bungs, which we last saw when the Government was encouraging people to contact out, will be back. Look out for bungs to keep people who wouldn’t normally be saving-saving.
5. Auto-enrolment can be supported by bungs, it can be a winner
6. If auto enrolment works, the Government can take its foot off the accelerator peddle on the state pension (the triple lock).
7. People will be sold pension freedom as freedom from tax in retirement, so long as they choose to pay it up front!

I actually like this idea. I suspect that it won’t be dressed up as TEE and that there will be enough “universal saving incentive , for people to claim we are still getting a “flat rate” of incentives. Knowing the Treasury,  we’ll all be a little better off than saving directly into an ISA- if only to remind us this money can’t be spent any time soon. Whether it has anything to do with a “pension” is another thing!

Looking back at my submission to the Treasury last year (you can search it on this blog), this was my direction of travel. I didn’t get this far down the road, but rather hoped this would be the kind of place we’d end up.

And the losers?

Whenever such a system was imposed is going to be a black day for those managing money. Insurance companies, master trusts, SIPP managers and all those who rely on taking a clip (sorry “Ad Valorem”) on funds under management and/or contributions will see a fall in expected revenues. There will be less money in the pension system because a lot of it will be with the Treasury.

Ironically, one big loser in this, is NEST, which depends more than most on contribution flows.

Enough winners?

Those running DB schemes will like it, they will be able to shave off liabilities every time the “Scheme Pays“. The closed ones will move quicker to wind-up and the open ones (the Government schemes) will be trimmed in their scope (something the Treasury thought they’d lost their power to do). The apartheid between the haves and the have nots will be (partially) addressed.

There are enough winners out of such an approach to win overall support, but let’s be in no doubt, this is a very radical plan which will hurt those used to making substantial pension contributions for themselves, having substantial contributions made on their behalf and it will hurt employers  who have got used to paying private pension contributions rather than national insurance.

Re-nationalising pensions

I’ll leave you on that thought as it sums up how I see what the Treasury seem to be up to. In a rather strange way, a Conservative Government is creating the means to pay for our future welfare state and (say it quietly) – “a Conservative Government is doing it at the expense of the private sector’s golden goose – the financial services industry”!