Simplification is the key - Centre for Policy Studies

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Table 6: The complexity of the tax treatment of savings 50 Savings product Tax treatment and main tax attributes Other features Pensions ISAs Single premium life assurance bonds (onshore fund) Regular life fund contributions/Maximum Investment Plan (MIP) Collective direct investment scheme (OEICs, Unit Trusts) EE partial T. “Middle E” is only partial as the 10% dividend tax credit is not recoverable. 25% tax-free lump sum can be taken at retirement. TE partial E. Partial “middle E” as per pensions. TTE partial , with “middle T” being taxed at the life company’s special rate (20%); HMRC treats this as if basic rate tax has been paid so investors do not have to add the income to a tax return. The “E” is partial because withdrawals of up to 5% of the original investment can be taken over 20 years without immediate tax. Higher rate tax (HRT) payers making withdrawals over this amount, or after 20 years or on complete encashment (whichever is the earlier) face additional income tax. TTE; “middle T” taxed as a life bond. “Final E” requires the fund to be held for a minimum of ten years to be deemed a “qualifying policy”. There is then no tax on withdrawals. This is a benefit for a HRT payer as the tax on the life fund during the period of investment is often less than his personal tax rate. TTE partial , with E being partial as asset realisation is subject to CGT; disinvestment needs to be planned. Large contributions allowances, but restrictions on how benefits can be taken. Contributions limited, but instant access. Unlimited investment amount. Investors are free to spend life policy proceeds as they wish. Unlimited investment amount. Unlimited investment amount and benefits can be taken at any time and in any format. 50 Table 6 describes a product’s tax status chronologically by using three letters, either E (exempt) or T (taxed). The first letter refers to contributions (of capital), the second to investment income and capital gains and the last letter to post-retirement income (e.g. a pension). 15
Many savers are particularly bewildered by the tax treatment of life bonds, 51 which are taxed very differently to pension funds. A life bond commingles long-term investment with a single premium life assurance policy, and it is this latter feature that provides life funds with their “non-qualifying” tax status. 52 This is in spite of the life assurance element of the investment being very small (i.e. less than 1% of the amount invested). Consequently, life funds pay tax but can deduct the expenses of writing new business against capital gains, thereby reducing their effective tax rate on gains to less than 20% (industry numbers range from 15% to 18%). Conversely, pension funds do not pay tax, and therefore cannot offset their expenses. HMRC treats life bond investors as if full basic rate tax has been paid, a benefit that insurance companies are keen to point out via “technical notes” to investors when selling investment bonds against other investment funds. But these notes never disclose the rate of tax that the life fund could expect to pay in the future, because it varies, depending on the financial position of the insurance company. This leaves the investor (or his adviser) to guess the true extent of the benefit. More complexity to wrestle with. Finally, tax relief adds to complexity because product design is often driven by the need to maximise tax benefits rather than meet customer need. Why, for example, are life insurance policies embedded into savings products which are regularly sold to trusts designed to benefit children? The answer is related to tax and, historically, sales commission (the latter will end once the Retail Distribution Review 53 has been implemented). 2.4 Taking income in retirement: more complexity Individuals retiring with appropriate pension rights can commute up to 25% of their pension fund as a tax-free lump sum. Thereafter, but prior to reaching the age of 75, retirement savings must either be used to purchase a lifetime annuity 54 or be taken as unsecured income. 55 51 52 53 54 55 Life bonds are also known as investment bonds which, confusingly, are nothing to do with the (fixed income) bond market. The Taxes Act 1988 specifies that single premium life assurance policies cannot be “qualifying” policies. The underlying fund is therefore taxed on investment income and capital gains under the special rate of corporate tax applicable to life assurance companies: 20%. See Sections 4.7 and 4.8. The May 2010 Coalition Agreement proposed the abandonment of compulsory annuitisation at 75. Introduced in the Finance Act 2004 after the Plymouth Brethren objected on religious grounds to compulsory annuitisation (which is against EU law). 16
Page 1 and 2: Simplification is the key Stimulati
Page 3 and 4: THE AUTHOR Michael Johnson trained
Page 5 and 6: A note concerning data Finding a co
Page 7 and 8: These proposals depend upon having
Page 9 and 10: SUMMARY The UK’s long-term savin
Page 11 and 12: any annuitisation requirement, prov
Page 13 and 14: Thus, had pension savings products
Page 16 and 17: INTRODUCTION There has been a flood
Page 18 and 19: PART ONE: THE LONG-TERM SAVINGS LAN
Page 20 and 21: Japan’s savings ratio was once th
Page 22 and 23: scheme contribution rates are lower
Page 24 and 25: Table 1: Funded pension scheme asse
Page 26 and 27: 1.9 The international perspective A
Page 28 and 29: Table 4: ISA savers’ income distr
Page 32 and 33: Figure 4: Income options upon retir
Page 34 and 35: savings by delivering a framework t
Page 36 and 37: Figure 7: When non-savers might sta
Page 38 and 39: There are other aspects to consider
Page 40 and 41: 3. THE EMPLOYERS’ PERSPECTIVE 3.1
Page 42 and 43: When employees with DC funds retire
Page 44 and 45: More specifically, employers are no
Page 46 and 47: Both businesses do have important c
Page 48 and 49: year. 91 Clearly, there are conside
Page 50 and 51: elderly and the wealthy, not least
Page 52 and 53: 5. THE TREASURY’S PERSPECTIVE 5.1
Page 54 and 55: Whilst the UK’s NRR for the mean
Page 56 and 57: Currently, reducing pensioner pover
Page 58 and 59: Table 13: Net cost of tax relief un
Page 60 and 61: TEE would be hugely attractive to p
Page 62 and 63: 5.6 Tax treatment: international pe
Page 64 and 65: PART II THE PROPOSALS AND THEIR IMP
Page 66 and 67: Proposal 6: post-retirement, amend
Page 68 and 69: 7. TAX SIMPLIFICATION: SOME OPTIONS
Page 70 and 71: 8. THE IMPLICATIONS FOR SAVERS Impl
Page 72 and 73: The higher rate taxpayers’ perspe
Page 74 and 75: segregated from any employer-sponso
Page 76 and 77: epresent a further step down the pa
Page 78 and 79: 10. THE IMPLICATIONS FOR THE PENSIO
Page 80 and 81:
Such principles would have to ensur
Page 82 and 83:
Figure 13: The cost of pension savi
Page 84 and 85:
pool of underlying pension assets (
Page 86 and 87:
hardship” facility, whereby cash
Page 88 and 89:
occupational pension scheme benefit
Page 90 and 91:
CONCLUSION We would save more, for
Page 92 and 93:
ACKNOWLEDGEMENTS This paper was cat
Page 94 and 95:
APPENDIX I Summary of proposals fro
Page 96 and 97:
APPENDIX II Value of assets in priv
Page 98 and 99:
depending upon age at the time that
Page 100 and 101:
APPENDIX V PRE-RETIREMENT ACCESS TO
Page 102 and 103:
APPENDIX VII FINANCIAL PLANNING TOO
Page 104 and 105:
APPENDIX VIII THE MODEL 173 The
Page 106 and 107:
GLOSSARY Alternatively Secured Pens
Page 108 and 109:
pensions and earnings, but excludes
Page 110 and 111:
those with earnings above £4,940 b
Page 112 and 113:
in cash terms, i.e. fixed at £770
Page 114:
The UK savings industry is barely t
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