Simplification is the key - Centre for Policy Studies

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Currently, reducing pensioner poverty is clearly not the objective: tax relief is heavily skewed towards the well-off, not surprising given that they pay more into a pension and their relief is at the top rate of tax. Higher rate taxpayers (12% of all taxpayers 111 ) get 60% of total tax relief 112 and, until the Budget of April 2009, 25% of tax relief went to the top 1% of earners. 113 (This could now roughly halve although predicting contributions from additional rate taxpayers is hazardous). The abolition of higher rate tax (HRT) relief (i.e. at 40%) has been predicted for years, with the run up to past Budgets being accompanied by proclamations from the industry (keen to protect its most lucrative client base) that ending HRT relief would make little impact on the Treasury's finances. The 2009 Budget measures will save about £2.3 billion a year (in respect of additional rate, i.e. 50% taxpayers), but if 40% relief were also abandoned, the annual saving would be over £7 billion. 114 5.4 How effective is tax relief? Just how effective is the Treasury’s £36.6 billion investment? Could the same spend be deployed in a different way that would lead to more people saving more for the long term? If savings with instant access, but which exhibit high persistency, count as “long term”, ISAs can be compared with other forms of personal pension saving (i.e. personal pensions (PP), SIPPs and occupational schemes, excluding employers’ contributions), as Table 12 does. Table 12: Savings and tax relief, 2007-2008, £ billion 115 Amount Tax relief Tax relief* Amount saved saved "Front E" "Middle E" ÷ total tax relief Occupational schemes (employees only) £14.6 £4.4 £1.1 2.7 PP schemes (employees only) + self employed £10.3 £3.3 £0.8 2.5 SIPPs (to address under-reporting)** £3.0 £0.9 £0.2 2.7 Total pension contributions excl. employers £27.9 £8.6 £2.1 2.6 Cash and Stocks & Shares ISAs £35.7 n/a £2.4 14.9 * In respect of pension savings, "middle E" is an estimate based upon Table 11 ** Tax relief based upon HMRC's reported 30% average rate of relief on contributions 111 112 ONS, Table 3.4, Income tax liabilities, 2006-07, December 2008. PPI, Pension Facts, Table 26; Percentage of total tax relief on individual and employee, December 2008. 113 HM Treasury & HMRC, Implementing the restriction of pensions tax relief, page 5, December 2009. 114 115 Using the latest tax relief distribution data available (HMT, Income and Deductions 2006-07, Table 3.5, 2008), 2,232,000 people earned at least £50,000 in 2006-07, and 1,856,000 of them claimed tax relief totalling £13.79 billion (all at 40%). Cutting this back to 20% would save £6.9 billion (considerably more in practice because the 40% tax threshold in 2006-07 was less than £39,000). HMRC, Cost of reliefs for approved pension schemes, Table 7.9, September 2009. ISA tax relief from HMRC's Tax Expenditures Table 1.5, March 2010. Amounts saved from ONS, Pension Trends, Chapter 8, Table 8.14, April 2010. 41
Employees saved £27.9 billion in pensions vehicles in 2007-08, with tax relief on contributions being £8.6 billion. In comparison, ISAs attracted £35.7 billion of new savings 116 at a cost to the Treasury of £2.4 billion 117 in respect of “middle E”. The new savings/total tax relief ratio of ISAs was more than five times that of pensions saving. Does this suggest that ISA tax relief is a more effective investment for the Treasury? Unfortunately, we are not comparing like with like, the tax treatment of pension savings being EET, whereas ISAs are TEE (contributions being made out of post-tax income). Consequently, the tax relief on ISAs is in respect of investment income on the existing pool of ISA assets, £221 billion at the end of the 2007-08 tax year. In addition, the “cost” to the Treasury of “back E” (tax-free withdrawals) is not included. That said, over the full lifetime of a basic rate taxpayer, the present value of tax relief cost of an ISA and a pension are comparable (assuming that in both cases a lifetime annuity is purchased at retirement, and taking into account pensions’ 25% tax-free lump sum). This, however, is not the case for higher rate taxpayers because most of them only pay 20% tax in retirement. We need to be able to “value” the instant access to assets that ISAs offer, or the “negative value” of having to tie up pension savings until at least 55 (from April 2010). Industry surveys suggests that instant access is worth a lot (in terms of attracting savings), but it is hard to quantify the value. We also need a better understanding of the extent of the motivational benefit of upfront tax relief, but there is evidence that many people (particularly amongst the low paid) do not even appreciate that it is available. Indeed, the Treasury has a vested interest in savers’ asset performance because when it provides upfront tax relief on pensions contributions (EET), it is effectively co-investing with the saver, enjoying a funding advantage as the cost of Gilts issuance is likely to be less than the long-term investment growth rate. But the Treasury only recoups its investment, and maybe even realise a “profit”, when it taxes the income derived from post-retirement asset realisation. It does, however, collect tax on the realisation of 75% of all of the assets, having funded only 20% to 40% of them. 5.5 Alternative approaches to tax relief Table 13 models a variety of alternative tax treatments of registered pensions schemes and compares them with the actual net cost to the Treasury (using EET) for 2008-09. 116 ONS, HMRC, Table 9.4 for 2007–08. 117 HMRC, Tax Expenditure, Table 1.5 for 2007–08, April 2009 (included PEPs). ISA tax relief (on accruals, “middle E”) in 2008-09 was £2.2 billion (est. £1.6 billion in 2009-10), these reductions being due to falling interest rates (HMRC, Table 1.5, March 2010). 42
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 30 and 31: Table 6: The complexity of the tax
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 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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