Tristan Hawthorne is right to rail against the IFS (and the BBC) for lumping pension contributions into the “taxes” box on our payslip. Here’s the offending statement which appeared on the BBC website
The taxes that many of us are most aware of are income tax and National Insurance contributions (NICs).
These are the sums of money on a payslip that never reach our bank account, along with pension contributions or student loan repayments.
Together, they account for the majority of revenue collected in the UK.
Here’s that tax “grab in a graph”
And here’s Tristan’s vivid riposte
“For those of us in the benefits industry this is misleading at best and at worst worryingly inaccurate”.
One of my preoccupations is trying to find ways of getting ordinary people to think about the abstract concept of saving for retirement, putting money away for a rainy day and I wonder whether the idea of a “voluntary tax” isn’t such a bad one.
Obviously the reason we don’t like paying taxes is that it leaves us less to manage on when we pay our bills, but put the word “tax” in the title of a blog, and a lot of people will press the link, because we get “tax”. We understand the link between the amount we pay in tax and the level of public service we get.
When I pay 20% VAT on my burger, I accept that that is an amount that will go towards mending the roads that the burger van will drive to deliver tomorrow’s burger. There is a performance target that I expect for my money and that is to have my burger delivered on time (make up your personal targets in your own time).
With pensions it’s a little different
But with pensions it is a little different. We sort of know that our national insurance is buying us rights to benefits if something goes wrong and an income in later life which should keep us off the streets. We kind of know – if we’re in a defined benefit scheme that our pension deduction buys us a share of our final or average salary at some date in the future.
Where things come apart is when we mix up saving into a pension pot with a tax, because pension pots are – as Tristan says – just a kind of very inaccessible bank account and the amount in that account is determined not by some unseen actuary in the sky, but by how you did.
This is why Tristan goes off on one.
Since pension freedoms came in, DC can pretty much act like an ISA, except with different tax treatment, once you are age 55.
You can access as much or as little as you want, as an income or as a lump sum. It is literally your money, in a segregated investment account. While very few people would ever do so or would be advised to do so, you could place all that money into cash at age 55 and it would almost act like a bank account.
So again, it is deeply misleading to the point of inaccurate to claim that pension contributions never reach your bank account. In the case of DC it is almost a bank account in the first place!
Now let’s be clear about this, people generally do see a payslip deduction as a “tax” , Paul Johnson who wrote the paragraph that offended Tristan is right about that.
People do get to spend their pension savings – either tax-free or after tax, and they buy real things.
People get workplace pensions as a voluntary tax-grab and they kind of know that that money comes back to them.
What they don’t know, and this is where the pensions industry makes its money, is what happens in the middle.
Paul Lewis’ wealth or pension tax
Paul Lewis talks about pension taxation not in terms of what the Government takes (it takes very little of the money as it grows) but in terms of the taxes the private sector take on your money.
This kind of pension tax is levied through very small charges which add up to an amount that can erode your pension “bank balance” by up to a third. You might think it impossible that a 1% pa charge on your savings can lead to a pension tax on your final balance of 30% but that is what the maths says and the maths doesn’t lie.
But simply looking at the cost of pension pot management in terms of cost is stupid, all that tax on your savings pays for something, just as VAT and national insurance and income tax pay for something.
They pay for the value you get out of all this pension saving.
The value you get from pension saving is a reward for putting the money away for a long time and not touching. It’s a reward for patience and it’s given you by the people who benefit from your money. In economics terms it’s what you get from patient capital.
We have a right to know what this reward is and whether the people who have managed our pot have given our fair shares. We have a right to know how our savings have done, and if we want to use the phrase Tristan hates, we have a right to know how our pension tax has done.
But we don’t get the right to know how our savings have done
While pension providers have become very expert in taking money off us via payroll taxes, and are increasingly good at giving back to us using pension freedoms, what happens in the middle remains a mystery.
We don’t know what happens to our money and we don’t know how our savings are rewarded , we don’t even know how much we are paying third parties to look after our money.
Which is shocking!
Instead we get a whole lot of paper we don’t read with graphs and tables that describe what has happened to funds and strategies, none of which is directly applicable to us.
We simply don’t get a statement on how our money had done and certainly not a meaningful statement on how we’ve done compared to everyone else.
When I look at that chart (scroll up) at the top of this blog, I see that about 35% of my money is paid to the Government to look after me. Reading that, I’m saying – so what.
I want to know what that 35% means compared to other countries, other Government tax-grabs. Fortunately, those numbers are to hand
Which makes me feel a little more comfortable, so long as I am an average citizen. Then I ask myself what being an average citizen mean and I discover that actually the average person on £28,000 a year is doing very well against the average person abroad but that the rich person is doing about average
I hope that like me, you find these charts compelling. They would be even more compelling if I could put in my and my partner’s income and compare ourselves individually.
But we recognise that working out the value we get from our tax is a lot harder than working out the tax we pay. So economists and tax-payers call it a day about now. Because we know that we will never quite know whether we are getting individual value for money and are prepared to accept we are part of a collective set up.
Why DC is different
But back to the bank account and Tristan. Tristan is fundamentally right. Taxing people to build up a private pension pot is just a way of paying people later and is quite different from paying into one big pot from which Defined Benefit pensions are paid out.
DC is different because we get to see the fruits of our savings as a bank account as we go along and as a spendable bank account from aged 55.
Whereas we can’t really get granular about how our taxes have done and demand “hypothecation” of our taxes paid, we can get super-granular about this pension tax into our DC pot.
We can and should be able to see where our money is going, what it did (good and ill) and what reward we got for waiting for it to come back to us. We should also be able to find out how much of our money was paid to the people who looked after it for us.
We should not have this information passed to us in an abstract way – as “performance”, that is the old lazy way of governance – founded in DB reporting. We should instead have this information given to us as a score telling us -as Experian tells us- how we’re doing relative to everyone else.
Which is what AgeWage is doing, and is why AgeWage is going to be so important to us in the years ahead.
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