Pension tax-relief – a fact based argument for change.

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The change I am suggesting would turn pension taxation on its head, it would mean pension contributions would be taxed at more than 60% for high earners but that the lowest earners would be exempt from pension taxation.  Pension providers would need to pay attention to their low-earners who would become more valuable to them, providers whose models were focussed on wealth management would suffer from these proposals. Read to the end to understand why I see such change as needed.

In recent articles, I , Ros Altmann and Jo Cumbo have been grappling with pension tax reform. There are three solutions to the issues.

The first is to deny there is a problem , or at least to put off accepting we need to tackle the problem (this sounds familiar in the context of climate change).

The second is to look at a partial solution, the solution favoured by unlikely bedfellows in John Ralfe and Ros Altmann, here the key is to limit tax relief to a flat incentive.

The third is what I propose which is a phased transition from the current system where contributions get incentivised to a system where pensions are paid tax free.

In this blog, I look at the available numbers, published by the Government – that show us – on an accounting basis, how the amount that Government loses in tax relief exceeds the amount it rakes in from taxing pension saving by £35.4 bn (2017). Ros Altmann estimates that the real cost today has gone up since then to around £50bn, but I’ll stick with the lower estimate, as detailed below.

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The table has been converted to a graph which shows where the £35.4 bn is lost

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DB funding costs best part of £18bn,

The graph shows that the biggest cost by far, is the £18bn a year lost in tax revenues from employers with occupational pension schemes. This may seem odd to those who see pensions through the lens of auto-enrolment where employers pay 3% of a band of earnings and employees 5%. But in 2017 the rate was still 1+1. and more importantly, the weight of pension contributions is still with DB schemes. The deficit contributions to keep DB going are enormous, the ONS estimated that the 360 largest DB plans paid £13.5bn in special contributions in 2018 (and they paid ongoing contributions and the PPF levy on top).

DC costs to the pension system are smaller but growing

But we should also be aware that ongoing contributions to Defined benefit schemes dwarf what’s going into workplace DC plans.

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Look out for the yellow and blue blocks on the right to shoot up as the 2018 and 2019 numbers come in, that’s when the real cost of auto-enrolment to the Treasury arrives.

Lates estimates from the Treasury suggest the  cost of income tax relief for registered pension schemes in 2019/2020 will be  £20.4bn, (“income” covers personal income and corporation tax). Most of this increase is expected to come from DC

Why national insurance is so important

People and employers pay national insurance on salary and bonuses but not on pensions in payment.  Employers do not pay national insurance on contributions to pensions. Although national insurance is not a headline grabber (like income and corporation tax) it forms a big part of the £35.4bn gap between what Govt. gives up and what it grabs back



The figures in Table 6 at the top , need no graph, in terms of “give and grab”, the Government gives up £16bn in national insurance and grabs nothing back. National Insurance makes up nearly half of the gap between give and grab.

Although Table 6 is the last complete figures , we do have provisional data. The latest data from the tax office reveals national insurance relief for employer pension contributions will amount to £18.7bn, higher than the 2018/19 figure of £17.4bn, and the 2014/15 figure of  £13.8bn figure.

So what can Government do?

On the face of it, the ongoing cost of funding DB and the cost to the exchequer of lost NI revenues are the two biggest ticket items,  The DC costs are yet to feed through.

The current plan is to cap the amount of contributions that those with high net disposable incomes can make and punitively tax breaches . This is through the annual allowance, the taper and to some extent the money purchase annual allowance.  Coupled with a cap on the value of lifetime pensions benefits this has produced an increased “grab” from the wealthy illustrated below.



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But these breaches aren’t really netting much in “grab” compared with the “give” elsewhere.

What the Government has to do is to find a way to stop giving away so much upfront and boost the impact of the “give” by not grabbing back in retirement.

The reason for this is that 50% of the benefit of the current “give” is going to 10% of the population and the 90% of the rest of us , are sharing in only half that £35.4bn giveaway.

The beneficiaries of that big employer spend are those still getting DB accrual and those benefiting from DB pensions that increase each year. There is an argument that DB pensions should be liable to national insurance by way of “grab” . I don’t see such a measure as being popular, but it may be a short-term fix to keep the show on the road and pay for removing the annual allowance taper. These tinkerings are not the long-term solution

Making DB accrual benefit low-earners most.

What  needs to happen is that we need to gradually remove all the perks of accruing DB (both in the private and public sector) and charge those who are in receipt of DB accrual the cost of both the income tax and national insurance give , in exchange for paying this accrual tax free at retirement. This can be done , not by increasing payroll taxes but by offsetting the upfront tax and NI reliefs by a promise that this part of the DB accrual will be paid tax free – effectively a tax-exempt pension.

Why this works is that it redistributes the incentives to stay in to those who pay small amounts of tax and NI and takes away from those who are the big winners today, those 10% of top earners who are scooping the pool.

Preventing DC becoming a national insurance arbitrage.

As for DC, we have to be aware that most DC contributions will ultimately be paid by employers

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Employers are cottoning on to salary sacrifice/exchange and can see that they can boost pension contributions by up to a quarter by simply paying employee contributions in lieu of salary.

This graph shows how fast the switch is happening and when the vast new cohort of employers (1m +) who have recently set up workplace plans, cotton on to this, the amount of personal contributions will fall further.

If Government chooses to cap tax- relief on personal contributions to the lower rate , they will see that blue line accelerate towards zero as employer contributions protect all employees from income tax (as well as NI).

This is why a flat-rate solutions as proposed by most pension experts is flawed.

As with DB, the solution is to treat pension contributions as tax- able and liable to national insurance as if they were a benefit in kind. In the short- term, contributions could carry on getting tax-relief but would be “docked” by providers who would send the tax and national insurance  on  to HMRC.

This could mean that a higher rate tax-payer would only get around 39 p invested for £1 received by the provider. (45% income tax + 2% employee national insurance and 13.8% employer national insurance would be returned).

By contrast, 100% of the contributions for those on the lowest earnings (below both tax and national insurance thresholds would be invested.

Both the highest and lowest earners would see 100% of their savings available to them in retirement tax free, but the lower earner would benefit to the tune of 61p in the pound over his or her wealthy colleagues.

Impact on pension savings

The impact of my proposals will be extremely unpopular with most people reading this blog, who will benefit from the status quo and could stomach a flat rate incentive system.

Not only will it dramatically reduce pensions for the rich but it will slash revenue projections for many pension providers that depend for their profitability on an ad-valorem fee on wealth. Put simply , it will turn round the pensions value propositions from rich to poor, from wealth management to social insurance.

One test of this Government will be to see whether they will actually sort out pension tax relief as dramatically as  I propose. I propose that if they do, they look at incentivising people to convert their pension pots into pensions by providing tax-breaks to CDC schemes to manage people’s pensions as an alternative  to annuity, drawdown or simply cashing out the pot and putting the money in the bank.

The incentives for CDC provision could be equally geared to benefit those with small transfers so that the Government can make CDC viable for everybody, with the option for the wealthy to go their own way without imperilling the CDC scheme. As I have mentioned earlier, the first national CDC scheme could be seeded by the PPF and run by the PPF’s outstanding investment and operational teams.

I believe that in the long-term, my proposals will strengthen the UK pension system and return it to its former state of being the envy of the world. It will make pensions more inclusive and more relevant. Instead of being a “tax-wrapper” , the DC pension pot will become measurable by the CDC pension it can buy. DB pensions accrual will be valued for whom it is valuable and will increasingly be swapped for a CDC benefit based on a defined contribution.

Those who these proposals would benefit, won’t realise at first just how much they will get from this change. Those 1.7m people caught in the net-pay rip-off , don’t know how they are being ripped-off and have no voice. Those caught by the taper are the other way round, they have a loud voice and get their way.

But – with proper promotion, I believe these proposals will receive popular support. It will take a lot of time, energy and bravery to see these proposals through and the people who have most to lose from these proposals are going to be a huge barrier to change.

Those who will see the value of their future DB accrual , their future DC savings reduced, will not like my proposals. They will argue that it will destroy confidence in the pension system and many will opt-out and prefer to be paid salary in lieu.

Impact on employers

But employers will not be impacted by my proposals and will be under no obligation to feather-bed these cuts in top-earners pensions. As this system would be imposed on a national basis, the high-earners wanting out would need to find a country where they could get better. As far as I am aware, no country is currently giving away more in tax relief to the wealthy than Britain, so they will be hard pushed.

Employers will not be taxed  on their DB funding (or indeed on special contributions), they will not be impacted by the administration of the tax rebating which will fall to pension administrators not payroll.

My proposals should be welcomed by employers and their trade bodies , the CBI and the FSB alike.

Impact on the Health Service

My proposals will generate a substantial reduction in the cost of pension tax relief. It will especially negate the cost of tax-free cash (all future accrual or savings to pensions will be tax-free). The money saved can be recycled to encouraging the use of CDC pensions and to help pay for the cost of long-term care of our fast dementing  and physically detoriating elderly. This proposal will go some way towards increasing the £230bn a year we spend on the NHS.



About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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6 Responses to Pension tax-relief – a fact based argument for change.

  1. John Mather says:

    The red herring is the NHS

    The way to improve the NHS is to reduce the waste
    caused by self-inflicted diseases due to poor lifestyle habits.

    Slow suicide should be replaced by living long and dying short.
    Nutrition and exercise are subjects not taught to doctors in basic training.

    It is more accurate to call the present system the NDS
    Follow the money only pharma and food industry benefit from throwing more money
    at a dysfunctional model

    • Brian G says:

      If your proposed solution were implemented there is no remaining benefit to pensions. We may as well just have a new workplace ISA. Or everyone can have their own personal ISA where every employer and individual must place their compulsory workplace ISA contributions plus their 20k existing limits. If there is no remaining incentive to save on employer and employee tax and NI then there is no longer a point to pensions. As an individual I can see no benefit at all to your version of pensions compared to an ISA which already gives me what you are suggesting.

    • Eugen N says:

      It is hard to incentivise people to live healthy and do exercise. Personally I cannot see anything changing here. We have not manage to stop people smoking!

      The problem with NHS would become worse, especially if we cannot have a good planning and funding now.

      It is easy to blame it on Pharma, but they just respond to demand to keep people alive, and to reduce pain. As someone who looks all the time at the possibility of investing in all sectors, pharma is not on my preferred list to invest. The cost of R&D is phenomenal, and there is no guarantee that shareholders would get something back.

  2. There is a potential conflict of interests between medical consultants with lucrative private practices that indirectly benefit from NHS waiting lists. Where is the incentive to treat NHS patients quickly if that risks impacting on a steady stream of private customers?

    Big pharma have been incentivising doctors for years to prescribe their drugs – conferences in Switzerland, freebies, etc. We need a bigger marketing push for exercise and healthy eating. More common sense and research into traditional remedies. Whether herbal or similar.

    As for pensions – flat rate tax relief at 30%!

  3. Ros Altmann says:

    Dear Henry,
    Having National Insurance relief has not made sense to me since I started working on pension incentives. I did recommend to Treasury in 2015 that it should consider removing NI relief and redistributing the money saved (or at least some of it) to lower earners to boost their pensions directly. Unfortunately, the Treasury did not wish to do that, despite my warning that most newly created auto-enrolment schemes in larger or medium sized employers were being done under salary sacrifice and that would make it much harder to remove NI relief in future. That seems where we are now.
    As regards TEE, I am so sorry to fundamentally disagree with you on this issue but I really do. Making pensions tax free on receipt will destroy pensions and just leave millions of future pensioners – who have spend decades putting aside savings for retirement – poorer in later life. Unless you only allow tax-free withdrawals, for example, to pay for social care needs and all other withdrawals are taxable, what would be the point of keeping money in pensions until your 80s? The future sixty-somethings would have strong behavioural nudges to spend their whole fund quickly, just in case a future Government decided that the tax-free withdrawal status is an unfair generational transfer and they need to get extra revenue, or to stop the pension funds being emptied quickly. With the current tax-free cash, even though the most sensible thing for most people from a financial perspective is to leave their pension untouched until they need it, almost everyone takes their tax free cash quickly, and many of them spend it on consumer durables, or holidays, or just put it in a bank account, just because it is tax-free and may not remain so. In future, your tax-free pension fund would be gone before it is most needed and people would fall back on means-tested benefits or would just be poorer and have less money to spend. One could build in an incentive to save for social care and use pensions as a tax-free care fund, in which other withdrawals are taxable. One could lock in the fund and only allow phased annual withdrawals up to a limit. But quite frankly I think the idea of giving an up front bonus, allowing that to build up tax-free, and then imposing some exchequer revenue in retirement (even a flat-rate pension tax can be considered) would preserve the behavioural sense of the current system. We must not, absolutely must not, turn pensions into ISAs. There are better ways to run pensions, please let’s discuss this and think about the long-term policy implications, not just short-term. I have huge respect for you Henry and admire the work you are doing, but on this issue there are some really important policy traps that we must be aware of.

    • henry tapper says:

      On the fear of future (double) taxation, I hear the same from those i know and respect (Steve Bee among others). I am not convinced that people will spend their retirement savings rather than risk them being taxed, though I take your point about people banking TFC today. There is the same fear around CDC and future Government’s behaviour.

      Unless we can trust Government to be fair in future, I don’t see how we can accept change. But you are closer to Government to me – and your worry should be my worry!

      But I do see ways of encouraging rather than mandating good behaviour, after all enrolment is optional and no one thought over 90% of us would stay in.

      What is needed is bold Government and if we can’t get bold Government now, we’ll never get it.

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