Strengthening the incentive to save: a consultation on pensions tax relief. RESPONSE FROM ICAS TO HM Treasury

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1 Strengthening the incentive to save: a consultation on pensions tax relief RESPONSE FROM ICAS TO HM Treasury 30 SEPTEMBER 2015 CA House 21 Haymarket Yards Edinburgh EH12 5BH +44 (0) icas.org.uk Direct: +44 (0)

2 2 Introduction The ICAS Pensions Committee welcomes the opportunity to respond to HM Treasury s paper Strengthening the incentive to save: a consultation on pensions tax relief (July 2015). Our CA qualification is internationally recognised and respected. We are a professional body for over 20,000 members who work in the UK and in more than 100 countries around the world. Our members represent different sizes of accountancy practice, financial services, industry, the investment community and the public and charity sectors. Our Charter requires ICAS committees to act primarily in the public interest and our responses to consultations are therefore intended to place the public interest first. Our Charter also requires us to represent our members views and to protect their interests, but in the rare cases where these are at odds with the public interest, it is the public interest which must be paramount. Key points We would not support a change in approach to pensions tax relief which would involve a move from an Exempt, Exempt, Taxed (EET) model to a Taxed, Exempt, Exempt (TEE) model. A lack of awareness amongst the general public of the availability of tax reliefs is insufficient to provide any impetus to a change in approach of this magnitude. Furthermore, transitional arrangements would be exceedingly complex, with people likely to find it harder to manage their tax affairs on retirement if they have a combination of retirement income which is taxed and income which is not taxed. The impact of the loss of tax relief on defined benefit (DB) schemes, which are open to future accrual and their sponsoring employers, is also a significant concern. We believe that the EET model has the potential to provide an incentive for more saving, especially in an auto-enrolled environment; therefore we would prefer to see further efforts by Government to raise awareness of the availability of tax reliefs rather than a change in the model. The EET model has another distinct advantage over the TEE model in that it helps preserve pension pots through acting as a break over cash withdrawal. This in turn helps people to save towards an adequate income in their retirement. We are concerned that introducing a TEE model alongside the recent pension freedoms could be detrimental to the Government s aim of better retirement incomes for all. We appreciate that there is a tension between the cost of pensions tax relief to the Exchequer and the pension reform agenda which is designed to encourage individuals to save more for retirement; in summary, the more people save the greater the cost of pensions tax relief. The way of addressing the tension between these two matters is to find the most effective way of targeting tax reliefs. This is in essence what the consultation is seeking to resolve but the consultation paper has not been developed in a way which reaches the heart of the matter either by offering a clear analysis of a number of options or by giving a sense of how far the Government is prepared to go in terms of lost tax revenue. Now that major reforms to our pensions system have been implemented, we believe it is the appropriate time for the Government to consider setting up an independent pensions/retirement savings commission as a standing advisory body which seeks to achieve long-term stability for the UK pensions system and cross-party consensus. As a general comment, the implications of any changes to the model for pensions tax reliefs arising from the implementation of Scottish Rate of Income Tax, from 1 April 2016, and the additional powers coming to the Scottish Parliament through the Scotland Bill 2015, should be considered as part of this consultation process or any similar consultation which takes place in the future. Tax reliefs are to remain reserved but their interaction with new devolved powers does add complexity to the taxation system and, potentially, to savings outcomes. For example, as things stand the amount of tax relief received by a Scottish taxpayer, or by a scheme on their behalf, would differ from a rest of the UK taxpayer s position in the event of the rate of tax in Scotland diverging from the UK rate. Any enquiries should be addressed to Christine Scott, Assistant Director, Charities and Pensions, at

3 3 s to consultation questions Question 1 To what extent does the complexity of the current system undermine the incentive for individuals to save for a pension? There is a general lack of public awareness of the existence of pensions tax reliefs and we welcome the Department of Work and Pensions efforts to raise awareness of this as part of its advertising campaign for auto-enrolment implementation. We believe that increasing public awareness about the existence of tax reliefs will encourage more people to save but the biggest challenge is encouraging people to save enough: we see under-saving as an on-going challenge for individuals and for Government. There are many reasons for undersaving, a major cause being a general lack of understanding of how much one needs to save to have a reasonable chance of achieving a required or desired level of income in retirement: this is especially true as reliance on defined contribution (DC) arrangements increases and defined benefit (DB) arrangements fall way. We are not convinced that moving from an Exempt, Exempt, Taxed (EET) model to a Taxed, Exempt, Exempt (TEE) model would ease the challenge of under-saving and would not consider supporting a change of this magnitude without strong evidence that it would. There are two significant practical barriers to change: First, transitional arrangements would be extremely complex as individuals and their pension providers would need to be able to distinguish between pension income derived under an EET model with that derived from the new TEE model. This could lead to an increase in the number of people falling into tax self-assessment and increases in the scope for errors to be made. Second, the loss of contributions to defined benefit schemes, arising from the loss of tax relief, would contribute to the pension deficits of funded DB schemes which are open to future accrual: these schemes already face additional funding challenges as a consequence of the abolition of contracting out. This would have a significant impact on employers who may already be funding deficit recovery plans and could be particularly problematic for employers participating in multiemployer schemes. For example, many charities participating in multi-employer schemes would like to cease future accrual with the aim of placing their finances on a stronger footing but are unable to afford the exit costs. In terms of product development under a TEE model, we believe that new products designed to deliver an income in retirement would be required. We do not believe that ISAs, which are designed for short and medium-term saving, should be used as the main vehicle for long-term saving. Therefore, detailed discussions with pension providers would be needed to determine whether a TEE model is genuinely suitable for long-term saving. Question 2 Do respondents believe that a simpler system is likely to result in greater engagement with pension saving? If so, how could the system be simplified to strengthen the incentive for individuals to save for a pension? We are not convinced that the complexity of pensions tax relief alone is driving under-saving, although for some people it may be a contributory factor and we comment on this later in our response to this question. However, we believe that people under-save for a variety of reasons and these include: low incomes; and a lack of understanding of how pensions work and how much needs to be saved, especially in a DC environment, to achieve an adequate retirement income. We understand that a major challenge with the current approach to pensions tax reliefs is targeting reliefs to where these are most needed. However, a consequence of this has been added complexity through the annual allowance, the annual allowance taper and the life-time allowance. While we acknowledge that the life-time allowance is now to be indexed and therefore not eroded further, the reductions in the life-time allowance over a number of years are a concern, for example, to middle income public sector workers who risk being caught.

4 4 For individuals with a number of different pensions, including a mixture of DC and DB, it is difficult to establish without specialist advice, whether or when they are likely to exceed the life-time allowance. This in turn could curtail saving or conversely increase the number of individuals likely to be hit with an unexpected tax charge. We would caution against any further changes to pensions tax reliefs which create further complexity for individuals, employers or the pensions industry. However, we would welcome a review of how recent Budget changes around allowances work in practice which would seek to identify and resolve in a practical way any unintended consequences. We comment again on the application of the lifetime allowance in our response to question five which is illustrative of the challenges around balancing simplicity with the targeting of tax reliefs and perceived fairness. Question 3 Would an alternative system allow individuals to take greater personal responsibility for saving an adequate amount for retirement, particularly in the context of the shift to defined contribution pensions? We do not believe that an alternative system of pension taxation would allow or encourage greater personal responsibility for saving an adequate amount for retirement. We are not clear why a lack of awareness of pensions tax relief should provide an impetus for significant reform and there is nothing to support the view that a) there would be a greater level of awareness of tax free pension income, and b) this would encourage people to save more. We believe that the EET model has the potential to provide an incentive for more saving, especially in an auto-enrolled environment; therefore we would prefer to see further efforts by Government to raise awareness of the availability of tax reliefs rather than a change in the model. The EET model has another distinct advantage over the TEE model in that it helps preserve pension pots through acting as a break over cash withdrawal. This in turn helps people to save towards an adequate income in their retirement. We are concerned that introducing a TEE model alongside the recent pension freedoms could be detrimental to the Government s aim of better retirement incomes for all. Question 4 Would an alternative system allow individuals to plan better for how they use their savings in retirement? We do not believe that an alternative system of pensions tax relief would allow or encourage individuals to plan better for how they use their savings in retirement. However, we do believe that people are not aware of how much they need to save while they are working to achieve the retirement income they need or want. We are aware that pension providers have been developing stochastic models which seek to address this challenge but it may take time for these to be widely used. These are likely to be most effective when an individual is able to provide information about all their pension pots and their wider finances. Question 5 Should the Government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated? There are existing differences in the way a DB arrangement and DC arrangement are impacted by the availability of tax reliefs and these differences are inherent in the structure of these arrangements: for example, the clearly defined pension promise offered by DB versus the absence of a promise under DC. We have not identified any additional differences which we would like to recommend; but there is one area where we believe that differences should be reduced. There is a differential between the application of the life-time allowance to DB pensions and to DC pensions. Someone reaching the life-time allowance under a DB arrangement will have a significantly higher pension than someone reaching the life-time allowance under a DC arrangement.

5 5 The Pensions Policy Institute s paper Tax relief for pension saving in the UK (2013) illustrates this based on a life-time allowance of 1,250,000: The reforms will affect members of Defined Benefit schemes and Defined Contribution schemes differently. After allowing for carry-forward, an individual who earns 40,000 with 20 years of service in a Defined Benefit pension scheme would need a 49% pay increase to breach the Annual Allowance. In contrast, without the carry-forward provision, the same individual [in a Defined Contribution scheme] would need just a 15% pay increase to breach the allowance. While we cannot offer a solution to this, we do believe that Government has a responsibility to reduce what is a significant difference between a retirement income available from a DB scheme and a retirement income available from a pot deemed to be the same-size from a DC arrangement. Question 6 What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How should these best be overcome? We refer, in our response to question one, to the significant challenges of introducing a TEE model. However, without a specific proposal it is difficult to go beyond the matters we raise in our responses to the other questions. Question 7 How should employer pension contributions be treated under any reform of pensions tax relief? It is difficult to answer this question without having a specific proposal for reform. However, we would expect that employer pension contributions would continue to be treated as business expenses: notwithstanding the position of those pension schemes which have been reported to HMRC under the regime for the Disclosure of Tax Avoidance Schemes (DOTAS). Question 8 How can the Government make sure that any reform of pensions tax relief is sustainable for the future? We appreciate that there is a tension between the cost of pensions tax relief to the Exchequer and the pension reform agenda which is designed to encourage individuals to save more for retirement; in summary, the more people save the greater the cost of pensions tax relief. The way of addressing the tension between these two matters is to find the most effective way of targeting tax reliefs. This is in essence what the consultation is seeking to resolve but the consultation paper has not been developed in a way which reaches the heart of the matter either by offering a clear analysis of a number of options or by giving a sense of how far the Government is prepared to go in terms of lost tax revenue. For example, Chart 2 A: Gross cost of registered pension scheme tax reliefs, clearly shows that there has been a steady increase in tax reliefs over the period. However, the real point is not how much reliefs have increased but how their relationship has changed relative to the income tax and national insurance due for the same period. It would also be helpful to consider alongside this any additional predicted cash inflows from the exercise of pension freedoms. For individuals planning and saving for retirement must be a long-term endeavour to be effective. Therefore, it is vital that successive Governments do not allow short-term policy aims to discourage individual saving or innovation by pension providers, or potential providers: this includes the potential for a future Government to reverse a TEE model of pension tax relief. A number of factors, including the decline of defined benefit pensions, under-saving by individuals, an aging population and pressures on public finances, have placed pensions reform at or near the top of the reform agenda for 21st century UK Governments. Now that major reforms to our pensions system have been implemented, we believe it is the appropriate time for the Government to consider setting up an independent pensions/retirement savings commission as a standing advisory body which seeks to achieve long-term stability for the UK pensions system and cross-party consensus.

6 6 A standing advisory body could advise Government on a rolling basis on global developments, trends and data such as they impact on long term saving. This would build on the provision in Pensions Act 2014 for a body to provide advice on life expectancy in the context of the State Pension Age review which is to be undertaken every five years.

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