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A Second Revolution In Pensions

July 27, 2015

 

Not content with kicking off one revolution for pensions, Chancellor George Osborne chose the Summer Budget to unveil a second one. This month’s consultation on pensions tax relief, “Strengthening the Incentive to Save”, really does ask us to go away and think the unthinkable – inviting views on whether tax relief on pension contributions should be abolished altogether.

 

For as long as anyone alive today can remember tax relief has been the carrot the government has offered us to get us to save for our retirement. Why else would you tie up your money for 30 years or more if you weren’t going to get generous tax relief on the way in? At first glance, this seems like a policy that is destined to be unpopular – so why would the politically astute Mr Osborne want to float it? Because he can save lots and lots of money.

 

The consultation reads like a pamphlet from Michael Johnson, the influential figure at the Centre for Policy Studies, who has for several years been arguing the government could clear the deficit in a single Parliament simply by reversing the way tax relief on pensions is given.

 

Johnson describes the current system as ‘EET’, which stands for Exempt, Exempt, Taxed. This means contributions are tax-exempt, investment growth is tax-exempt, but money coming out of the plan is taxed. Johnson has for several years now been calling for a Taxed, Exempt, Exempt (TEE) system, which sees contributions made from taxed income, like Isa contributions, growth exempt, and then income from the pension also exempt.

 

As the consultation spells out very clearly, the current system is very costly. In 2013/14 the government forwent nearly £50bn in uncollected income tax and National Insurance contributions for pensions. By rejigging the system, Osborne can hope to make savings on that figure. And the reason TEE is so appealing to Osborne is that it puts off Treasury spending on tax relief for up to half a century.

 

Here’s how it works. When an 18-year-old worker makes a contribution into an employer pension contribution through agreed salary sacrifice, the Treasury loses out in both income tax, employer and employee NI. The Treasury gets none of this money back until 40 or 50 years down the line when the individual draws their pension income.

 

Under a TEE approach, the Treasury gets to keep its £50bn this year, and only has to give it to the individual – assuming a cost neutral new system – years down the line, by which time Osborne’s place in history will be assured.

 

The problem is, can anyone tying up their money today trust a government years down the line not to change their mind and tax retirement income too? Abolishing tax relief risks undermining completely the public’s interest in pensions, and in saving for their future.

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