The ABI has commissioned the PPI to model the impact of a flat rate tax-relief structure for DC pensions in the UK. The case for reform is evident from the PPI’s analysis of who’s getting what incentives.

But as the report reveals, there is a lot more to the ABI’s proposals than meets the eye.  I wonder whether the purity of the report’s main findings isn’t diluted by a partial analysis of the solutions on offer.

A brilliant explanation of the inequalities of pension tax incentives

Methodically and without emotion the PPI has dissected the UK pension tax-relief system to who it biased towards the wealthy, towards men, towards the haves and away from the “have nots”. In short, it shows the tax-system to be in a shocking mess and the sponsors to the PPI’s report, the Association of British Insurers are calling for change.

What is the report saying?

The report is talking specifically about DC pensions (that famous oxymoron) which implies that DC pensions should be treated separately from DB pensions

• A flat rate of tax relief on DC pension contributions would increase the proportion of DC pension tax relief associated with basic rate taxpayers from 26% to 42%.
• A basic rate tax-payer, who works and contributes continuously to a pension could get around one fifth more from their savings under the current tax advantaged system than under a non-advantageous structure.
• A higher rate tax-payer could receive around half as much again from their savings.
• For every £100 of DC pension contributions made from gross earnings or by an employer, £32 of income tax has been relieved.
• The total value of contributions to DC pensions schemes was £29bn in 2018 from individuals and employers.
• Around £9.3bn of income tax was relieved in respect of these contributions.
• Since the implementation of automatic enrolment the proportion of pension tax relief going to those earning less than £30,000 has only increased from 23% to 24% despite the proportion of claimants increasing from 52% to 63%.
• 71% of tax relief on DC pension contributions goes to men, who make 69% of the contributions.

The ABI issued comment as the PPI launched its paper noting that

“Basic rate taxpayers make up 83.4% of total taxpayers but only receive 26% of the pensions tax relief related to Defined Contribution pension contributions”

So what is the call to action?

The report will probably be remembered for the headline in light blue above. But it is surprisingly assertive in the remedy it calls for, moving DC pensions to flat rate relief (implying DB tax relief would remain unchanged).

The report says that introducing a different tax regime for DC pensions to DB pensions could prove tricky and give rise to “unintended consequences including arbitrage opportunities“.

It is surprising that the issue of reform across all forms DB pensions are excluded and no good reason is made in the report for doing so. It may be that the ABI as sponsors decided to stick to its own, having little skin in the DB game anymore.

It is also surprising that the report says little about the impact of employer contributions and so much about personal contributions. The impact of moving to flat rate contributions is that it could require higher rate tax payers to lose 50% or more of personal tax relief but also be lumbered with a tax liability of 20% or more of the employer contribution.

This impact is touched on lightly- but not modeled. It is – alongside the treatment of national insurance on pension contributions the most contentious aspect of the flat-rate proposal.

Is the PPI the ABI at prayer?

The reference is to the Church of England which is (in some circles) regarded as the Conservative party at prayer.

I am sure that the ABI policy team are devout believers in greater fairness in society, but they still guard the estate of the British insurance industry and Government incentives to drive pension saving remain one of the insurance industries great value adds.

This chart does not split out the impact of DC tax relief from tax relief on DB pensions. Since the vast majority of pension contributions into DB and DC schemes are by employers, the chart really talks to the strain on the exchequer, not to the argument about personal tax-relief.

The net cost (the thin blue line) has risen from £23bn to £37bn over the first 17 years of the millennium.

Set against this, the cost of DC reliefs (estimated by the PPI) are quite small (£9bn).

If we accelerate the HMRC 2017 net number through to today and call it £40bn, then DC is not even a quarter slice

Dealing with DC in isolation from DB, means dealing with less than a quarter of the pension incentives budget . Which is odd.

It is hard not to see the report as a “local fix” not a societal solution. The ABI may have gone to church , but they seem to  control the order of service.

It is up to commentators such as me to explain that there are other churches and that while all churches agree on fairness, some see solutions to the societal problems differently than others.

Conclusions

It’s a good and timely report and its analysis of inequality is excellent. But it is only addressing a quarter of the Government’s incentives bill and the solution it models is a lot more painful to the mass-affluent than the report implies. Lumping a 20 or 25% benefit in kind tax on an employer contribution of more than £10,000 would not sit well in the aisles.

I would have liked the report better if it had focused on analyzing how the inequalities it highlights are created and less on modelling various flat rate solutions.

The report also takes a  swipe at CDC schemes

Being a DC scheme primarily operating as an alternative
to DB they present a potential conflict point in the system.

This is unworthy of the PPI who know better. (They are looking to run a project on CDC as an investment pathway for DC funds). There is currently no DB pension scheme looking to convert to CDC nor any employer I know who wishes to convert DC to CDC who wants CDC to be considered as a defined benefit.

I am pleased that the report is vocal on the net pay anomaly, though there is more information in the public domain about its impact than the report picks up on. It was very good to see Lesley Carline of the PMI picking up on the net pay issue in the pages of Professional Pensions . Fixing incentives for the 1.7m low paid affected should not have to wait to a more general review of pension taxation.

Pensions Management Institute president Lesley Carline agreed. She said: “Amending the rate of tax relief is all very well, but the rate itself is just one inequality and fairness requires us to address them all. Firstly, there is the relevance of tax relief to members of defined benefit schemes since there is no direct correlation between contribution rates and benefit accrual. Secondly, and probably the most pressing at the moment, is the anomaly between the net pay arrangement and relief-at-source for DC members who are low earners.”