We are due after July 4th, a general review of pensions, which has got the big guns at the IFS excited and top gun- Steve Webb (ex IFS) very excited indeed. So excited that he has gone to press (FT Adviser) to deliver his radical alternative to the present pension taxation system.
Pension tax relief could be rebranded as ‘matching’ or a ‘government top-up’ and could be restructured to give a big boost to lower earners.
For example, suppose savers were told that for the first £5,000 each year they put into a DC pension the government would also add £5,000, for the next £5,000 the government would add £2,500 and for the rest (up to a cap) the government would add £200 per £1,000.
This could greatly simplify the whole business of pension saving with no need for complex annual allowances and could make topping up your pension as easy as transferring your money between bank accounts.
Matching contributions would be much easier for people to understand and may be more likely to incentivise voluntary pension saving.
In the past, Sir Steve has advocated a flat rate of tax-relief to achieve this more targeted approach , an approach with Rachel Reeves has also toyed with, but such a system falls prey to salary sacrifice which effectively trumps personal taxation by making all contributions , employer contributions. Higher earners end up getting higher rate relief and potentially a lot of national insurance saving too.
The Webb formula is different and better, as it requires contributions to be made out of salary, which means national insurance is paid and salary sacrifice is of little value as the “top-up” is only paid against money “put” into pensions by savers.
It would probably only work well for DC saving and Webb has two other ideas
- To operate a different tax regime for DB (eg the current regime)
- Deal with DB as a public sector issue and manage the cost of incentivisation through the benefit formulae not tax-relief)
DB is now a means for accruing pensions for around one million workers and almost all of them are in the public sector. The contribution rates for public sector employees can be adjusted so that it is cheaper for low and middle income savers to buy pension than for the higher salaried. The higher salaried get an offset of the cost through tax relief so we end up with a uniform cost of accrual, rather than the current system where the poorest pay the most for their pension pound.
Webb is right to feed this into the debate now. The issues of tax relief are indeed about incentivising the right behaviour. We need to know what the right behaviour looks like and for that we need to establish a common purpose. In my view the common purpose of a pension system should be to ensure that everyone has dignity in retirement through a “wage for life” pension.
This definition excludes such aberrations as spending the pot on a fast car or hoarding the pot as an inheritance. A system of top-ups as outlined above , could be aligned with rules about the taking of benefits that did not encourage hoarding (taking away inheritance benefits) just as they penalise early spending (as happens today).
DC needs to be EET not EEE and the sooner tax exempt intergenerational transfers are stopped – the better
The DB system did not need a common purpose. Apart from the odd cash-balance plan, a DB pension gave you a defined benefit pension. The lack of freedom meant that the taxation system could be aligned to the purpose of those sponsoring the arrangement (typically the purpose of HR and reward to hire and fire high value employees).
Relief at Source, as Webb recognises, is not tax-relief but an incentive. The non-taxpayer gets RAS on pension contributions – whether a low-earner paying into a workplace pension like a GPP or Nest, or as a child being gifted a stakeholder pension (or similar). The basic rate element of RAS incentivises non-tax payers to save.
So we are already on our way to a de-linking of tax-relief and tax-payment. Webb’s formulae go a stage further. They are simple to explain, easy to understand and will go down well with a workforce that understands BOGOFF rather better than marginal taxation.
Once again, I find myself agreeing with Steve Webb, which is rather awkward but ultimately for the best.