While the nation was working out Dancing on Ice and the new #loveisland line-up, I was engaged in an intellectual arm-wrestle with amongst others, Mike Otsuka, John Ralfe, Sam Pickford, Steve Bee and (in the stands) Ros Altmann.
The topic, how we can reform pension tax-relief fairly, sustainably and acceptably to the pension saving public.
Some change must happen
It is clear that on March 11th, the Government will publish its findings into the problems for high earning clinicians arsing from the pensions annual allowance and the taper which creates occasions when going to work costs doctors money. We can’t carry on like this and the Prime Minister has promised change.
His party also promised a change so that 1.7m low- earners, who currently over-contribute to workplace pensions, can pick up promised incentives. While this is not seen as quite so urgent, it is something that it’s expected , the March 11th budget will address.
The broader issue is whether these local problems are symptoms of a wider malaise, whether we need to address pension tax relief with the kind of rigour we did in the 2015-16 consultation. What brought the wranglers to their keyboards yesterday surrounded that broader issue.
There are three positions
The first, stick broadly with what we’ve got, is Steve Bee’s – and I suspect most people in the pensions industry will be with him in calling for as little tinkering as possible.
The second position , which is the reformer’s position, is move to a flat rate system of tax relief where low-earners get an additional incentive (as if they were getting tax-relief at 30%) and that high-earners get less incentive (as if they paid 30 rather than 40 or 45% marginal tax).
There are two versions of this thinking, the RSA position simply looks at this as touching personal contributions. The second, and much more thought through position is that put forward by John Ralfe in his solution to the Doctor’s problems. John considers that higher rate tax contributions should be paid on all contributions, including those made by employers, whether in a DC or DB context. John wants DB contributions to be “deemed” by the DB scheme contributors, as the amount needed to meet pension accrual. John’s solution might involve a 10 or 15% tax bill on the total pension contribution – a considerably bigger amount than the RSA were modelling.
My position is more radical still and involves pension contributions being treated as a benefit in kind so that they are taxed , in the way that John wants, but at the contributors marginal rate. The only difference that pension contributions would receive, in my model, would be that employer contributions wouldn’t be subject to national insurance. However I would expect 100% of the money arising to be tax – free – whether paid as a lump sum or as a pension.
Ros Altmann’s view
I am not quite clear which version of the 30% flat rate relief argument Ros Altmann subscribes to, I rather suspect it will be John Ralfe’s. Writing on this blog she has made it clear that she has no time for my position because people would withdraw all their money when they got to 55, rather than risk the Government taxing them at later stage (and because they could with no tax to pay).
Ros Altmann is usually right in these things, though I think that some of the tax collected at the point of contribution, could be used to incentivise people keeping money in pensions (I see this as the way of getting CDC up and running under the auspices of the PPF).
Ros is probably right in thinking that my approach is politically unacceptable – both to the pensions industry (who would lose substantial revenue from reduced contributions) and to high-earners (who would have to choose to take a big pay-coding adjustment – or have their pot or benefits docked under scheme pays).
Ros’ more radical solution is to make auto-enrolment contributions non-tax deductible and to convert auto-enrolment to a compulsory contribution (effectively a pension tax).
I hold my ground but see merit in the Ralfe solution
The level of the flat rate solution can be set to achieve a desired impact. If the Treasury set the rate low – then there is an opportunity to raise revenues. If they set it high (and 30% is the highest flat rate I’ve seen quoted), it may (according to the RSA) be tax neutral. But I suspect it will not be national insurance neutral, if employer contributions are made without national insurance and employee contributions (for high earners) attract NI conts of 13.8% (er) and 2% (ee). Expect to see a shift towards non-contributory pension agreements in employment contracts or a greater promotion of salary exchange for voluntary contributions.
Ros Altmann is well aware of this problem, writing on my blog she states
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 Ros implies (and the chart shows), the cat is now out of the bag. It seems to me the major problem with a flat rate solution is in finding the right rate and that there is an argument that says that whatever that rate will be – will be tinkered with from time to time, allowing pension tax-relief to remain a political football.
Sticking my neck out
So I’ll stand my ground , knowing that I look very exposed. What my research has shown is that a 45% tax payer who gets the full rebate of 15.8% of the national insurance saved, may only be paying 39p in the pound of his or her pension contributions, while the low earner in a net-pay scheme pays 100p in the pound.
I will also stand up for payroll and say that pensions people are making a big assumption if they think that any kind of new taxation rate on pensions will be easy to administer. Transitional arrangements will have to start with a scheme pays option and there will have to be a heavy duty P800 solution and an extension to RAS – for incentives to be sent to pension schemes for employees on basic rate or nil rate income tax.
It may well be better to avoid a payroll fix altogether and simply tax the pension via scheme pays. If you are going the scheme pays route, then people’s cashflows aren’t impacted -the profit and loss is all in the pension and payroll are spared the agony (which is passed to pension providers).
A good debate
Thanks to everyone who helped this debate along this weekend (especially Mike Otsuka).
I think my position towards a 30% solution has softened , though I still prefer a more fundamental change.
I can now see Ros Altmann’s position better, mainly from understanding the intricacy of what John Ralfe is proposing.
I think Steve Bee is wonderfully laconic and I’ll end with my favorite tweet of the weekend (from the great cartoonist and pension guru)
Fair? I think a guarantee that deferred earnings will only be taxed once seems fair.
Sustainable? The EET system has effectively been in place in the UK since 1921. That’s 99 years!
— Steve Bee (@PensionsGuru) January 12, 2020