Strengthening the incentive to save: a consultation on pensions tax relief Response to the consultation document published on 8 July 2015 Grant Thornton UK LLP (Grant Thornton) has considered the proposals set out in the consultation document concerning the potential reform of pensions tax relief and welcomes the opportunity to respond. Grant Thornton's response Background The Foreword to the consultation document provides an overview as to the government's intention in seeking views from interested parties: With increased longevity and the changing nature of pension provision, the government needs to make sure that the system incentivises more people to take responsibility for their pension saving so that they are able to meet their aspirations in retirement. That is why the government is today publishing a consultation on pensions tax relief. If people are to take responsibility for their retirement, it is important that the support on offer from the government is simple and transparent, and that complexity does not undermine the incentive for individuals to save. It is also vital that the system is sustainable. Over the course of the last Parliament, the government took action to control the growing cost of pensions tax relief through the lifetime and annual allowances. The State Pension age was also raised, to reflect the pressure placed on the public finances by increased life expectancy. These difficult but important decisions have helped put the public finances on a more sustainable footing. In terms of a potential outcome, paragraph 1.5 of the consultation document states: The government is clear that the conclusion of this consultation may be that maintaining the current system is the most effective method of achieving the aims described above. The current system is based on a simple principle that taxation of pensions should be deferred until retirement. Paragraph 1.6 of the consultation document continues: However, the government is interested in views on the various options that have been suggested for how the system could be reformed. These range from a fundamental reform of the system (for example moving to a system which is Taxed-Exempt- Exempt and providing a government top-up on contributions) to less radical changes (such as retaining the current system and altering the lifetime and annual allowances), as well as options in between. Paragraph 3.8 of the consultation document sets out the parameters within which the government is considering reform: In considering the options for reform, the government will need to be mindful of a number of issues and competing objectives, including: 1
Any macro-economic implications of reform. In particular, the government will need to carefully consider the role that pensions play in financing long-term investment and the potential impact on financial markets, including the gilt markets, of any options for reform. The treatment of defined benefit and defined contribution pensions, including understanding the fiscal implications of changes, in particular for the unfunded public service pension schemes. The context of other changes to the wider personal tax system. The timing and implementation costs of any reform, for the pensions industry, employers and HMRC. At a high level, if the amount of relief provided in relation to pension schemes is to be reduced, there are a number of options that can be considered. These include: reducing the amount that can be paid into a pension by further lowering the annual allowance. This could be the simplest solution in the short term. This could however adversely impact on the self-employed as well as others who are able to make significant contributions for only a small number of years. providing a fixed level of relief in monetary terms would seem fairer but could be complicated to administer. It would also make it difficult to plan especially where earnings fluctuate. a move to Taxed Exempt Exempt (TEE) would require a great deal of system development and creates the prospect of two differing regimes running alongside each other. Any such move would require careful consideration. a flat rate of relief, or to increase simplicity, rate of government subsidy would seem the option most likely to increase savings for lower earners and reduce overall government spend on pensions. The contribution could be taken from taxed income and the subsidy could apply to both individual and employer contributions. It would be most effective if set at a realistic level above the rate of basic rate tax. Care should be taken to retain the incentive to the employer and therefore the National Insurance contribution benefit should remain. Bearing in mind the comments above, please see below responses to the questions posed in the consultation document. Question one To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension? For the vast majority of employees, the only pension decision they really need to make during their working life is whether they should join their employer's pension arrangement. This decision, if actively made, will be based largely on affordability and opportunity cost. Those individuals who wish to take more interest may consider the amount they pay and possibly change their investment funds. Experience to date of auto-enrolment shows that most employees keep to the default options and do not change their investment funds or contribution level. Our experience suggests that the greatest incentive for an individual to save is the prospect of an employer paid contribution. Many employers cannot afford to fund higher contributions across the board and instead offer matched contributions above the default level. Many employees simply will not increase their contribution if they are not getting anything in return from their employer. The more significant issue may therefore be the complexity and attractiveness to the employer of providing a pension on a more generous basis than they are compelled, rather than the complexity to the individual member. If the employer is not sufficiently incentivised to encourage higher contributions, it will also impact on what members pay. The government should consider what can be done to make pensions more understandable and attractive for the employer. A move to limit the National Insurance 2
contributions disregard for employers' pension contributions for example, could reduce the inclination of an employer to embrace pension provision. Disengaging key decision makers at an employer could be counter-productive. This is not to say that a senior decision maker will take a conscious view that if they cannot benefit, neither will the workforce, but in our experience, employers who take pension saving most seriously are often led by individuals who take it seriously themselves. Constant changes to the rules governing pensions and the consequent lack of certainty as to what tax breaks will exist in the future lead to negative press articles. A poor understanding of pensions by the general public and lack of financial education both act as barriers against improving the level of pension savings. This situation is exacerbated by pension communications and benefit statements that are difficult for most people to understand and include too much jargon. Question two 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 into a pension? The complexity of the pension system is not the only issue and a simpler system would not change the importance of affordability. Pensions complexity has the greatest impact on higher earners wishing to make significant contributions. The ability to receive a pension contribution from their employer is a greater factor in encouraging pension saving. We would support having a cross party, long-term agreement that no further tax changes to the detriment of the individual would be made. This would reduce the potential for further change and allow individuals to plan with greater certainty. It is important to make the distinction between genuine engagement as outlined in the consultation question and the outcome for the individual. Is it essential for people to actively review the extent to which they save or is it better simply to have employees saving at a level more likely to be sufficient for their needs in retirement? If the objective is to encourage greater saving, then a series of nudges or default options to achieve this objective will be more effective. It is important that the default options should give a desirable outcome. As evidenced by the take up under Stakeholder Pensions (where the vast majority of schemes remained empty shells), if it is left to the individual to make an active decision to fund for their retirement, in most cases nothing will happen. Although affordability is a reason why people do not save enough into pensions, the complexity of the pensions regime is still an important factor. If pensions were seen to be simpler, people would be less inclined to procrastinate about pensions saving. The government could implement several straightforward reforms to reduce complexity. Removing the lifetime allowance would remove substantial uncertainty and complexity. It would remove the issues around the many protection regimes and their enforcement. Other changes could include the abolition of capped drawdown and ending the block transfer restrictions to make it easier to transfer between schemes. Such measures would not cost the government much in terms of lost tax, if other tax incentives are reduced, but would remove complex areas of regulation. Pension scheme member communications should also be reviewed to ensure they are understandable and useful, rather than incomprehensible and full of terms not understood by most people. 3
Question three 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? The shift from defined benefit to defined contribution clearly places greater responsibility on the individual; a responsibility which is ignored by the majority. The shift to defined contribution schemes has taken place mainly in the private sector and a considerable divide exists between pension provision in the public and private sectors. Removing higher rate relief is likely to increase the rate at which defined benefit pension schemes go down the path of closing to new employees, then to future accrual and finally winding up. Two thirds of all the current relief on contributions goes to higher rate and additional rate taxpayers. These people are the most likely to save towards a pension because they tend to be better informed and have sufficient income to make contributions affordable. Reducing the level of government subsidy (rather than removing it completely) still offers these people an incentive to save tax efficiently. Adopting a flat rate of relief for all those who make pension contributions would ultimately achieve greater simplicity and make it easier for members to understand the benefit to them of the pension contribution. A flat rate of government enhancement would need to be set at a meaningful level, for example 30% or 33%, but we appreciate this may not significantly reduce the overall burden of tax relief. There are significant issues that must first be overcome, not least the need to update systems and to keep employers engaged with pensions. If a flat rate of enhancement is introduced, we believe that the lifetime allowance should be removed along with the tapering of the annual allowance for higher earners. These rules are currently very complex and restrictive. Question four Would an alternative system allow individuals to plan better for how they use their savings in retirement? The impact on the ability to plan will depend on the alternative system used. Most of the alternatives are unlikely to make much difference except if a TEE basis is used. In theory this could give more freedom and ability to plan, but it would also lead to further distrust in the pensions system and would be counter to moves to encourage greater pension saving. Other problems with TEE include the administrative and system changes needed, as well as the likely need to run two regimes side by side. One of the most significant disincentives to pensions saving has been the rate of structural change in the law and regulations governing pensions. Savers are unable to plan their pensions strategy with any certainty. Among many of the members we have talked to, there is a distrust of government and a belief that adverse changes could be implemented by future governments. This should be addressed by the government in its current reform considerations. Any changes will need to take into account existing accruals within pension schemes. It would be grossly unfair if reforms remove or reduce the expected benefits from these accruals. Such a move would further undermine trust in pensions and would be a clear disincentive to future saving. Changing the tax relief system alone is unlikely to help individuals plan better for the future. Most people live for today rather than planning fully for their retirement and factors such as affordability and financial education may be more important. Whether an alternative system would allow individuals to plan better for how they use their savings in retirement would very much depend on the system used. Purely removing the tax charge on withdrawal is unlikely to make a significant difference to an individual's planning. 4
Question five Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated? Ideally, the effective tax treatment under defined contribution and defined benefit pension schemes should be broadly equal. We could see merit to a system where limits on tax relief are related to benefits for defined benefit schemes and to contribution levels for defined contribution schemes, if the purpose was to deliver equality between funding through a defined benefit and a defined contribution scheme in a workable way.. Any such change would need to be carefully thought through. The lifetime allowance for defined contribution schemes should be abolished as it penalises investment growth It would be difficult for both systems to run independently and, for example, it would not seem fair if an executive with a defined benefit scheme could also receive relief on his defined contribution scheme and thereby increase further the total relief given. There are already very few defined benefit pension arrangements that are fully open outside the public sector. If tax breaks were removed or reduced, in a short time, even fewer defined benefit schemes would exist in the private sector. A change to a flat rate of relief or to TEE would cause administrative issues for all occupational pension schemes. Any move that would increase the cost to employers from having a defined benefit pension arrangement is likely to hasten their demise. Question six What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How could these best be overcome? Any reforms need to recognise the cost of change for employers and providers. Pension providers have spent many millions of pounds developing their systems for auto-enrolment, pension freedoms and solvency requirements. A further change requiring a significant spend may well cause some to withdraw from the market and therefore reduce competition. The likely reduction in average contributions from higher earners if tax relief is reduced will further reduce providers' profitability and appetite to continue in the market and would stifle competition and innovation. Payroll providers have had to cope with Real Time Information and are still grappling with autoenrolment. Further changes might necessitate additional protections for accrued benefits under existing schemes, adding yet another layer of complexity to the system. Employment law considerations, such as where there is an explicit term to provide a pension would need to be addressed. There would however need to be a balance between what would be fair to the employer and what would cause a large scale reduction of pension funding. Barriers include provisions in employees' contracts or that the contribution levels are contractual. TUPE regulations would need to be rewritten, as would the auto-enrolment legislation. There could be significant problems for those overseas holding monies in QROPS, as the home country of such schemes may not permit the required changes to take place, or at least not in a way that does not have serious tax consequences. It is clear that adequate notice must be given of any change. The impact will depend on the proposed change and each will have challenges including: 1) no change: significant cost of tax relief with much of the relief given to higher earners 2) lower the annual allowance: complexities remain and high earners may exceed the limits when auto-enrolled 5
3) have a fixed monetary value of tax relief (similar to the personal allowance): many people, especially the self-employed and those in sales roles, will not know what they can pay at the start of the year and may therefore opt out of pension provision 4) move to TEE: significant system updates needed; fundamental review of employment contracts required; payroll upgrades; generally increased cost burden on employers; possible need to run two regimes alongside each other 5) flat rate of relief: widens inequity for non-tax payers under contract based and occupational schemes, system upgrades required and most likely all schemes would need to operate relief at source. Higher rate taxpayers may become disengaged with pensions. To be effective, the relief would need to be in the region of 30% On top of the above, there will also be difficulties applying the changes to defined benefit schemes. A move to TEE would reduce the incentive for both employer and employee to make pension provision and therefore would be likely to require an increase in the default contributions under auto-enrolment. Question seven How should employer pension contributions be treated under any reform of pensions tax relief? Any move to reduce the amount of tax relief available to employers would reduce the attractiveness for them to provide pensions at any level beyond the statutory minimum. This could take many forms, including employers deciding against a planned increase in contributions or less of an effort being made to engage with employees and help them review their contribution levels. Such a move could be resolved to some extent by increasing the required minimum contribution under auto-enrolment, but that would have an impact on profitability by further increasing employment costs. If employer pension tax relief were unchanged while relief on individual contributions was reduced, many employees, especially senior executives, would negotiate increased employer pension provision. This could be resolved by taxing employees on the employer pension contribution, under a flat enhancement arrangement, both the employee and employer contribution would be uplifted by government. Alternatively there could be a limit on the pension contribution on which an employer could receive tax relief in respect of any individual to, say, 20,000 per annum. Consideration should be given to using government incentives to encourage employers to make more generous pension provision. This could as an example take the form of greater relief for employers who offer matched contributions above the auto enrolment minimum level. One group that should not be ignored is the self-employed. The self-employed are a group (mostly) outside of auto-enrolment, where pension provision is often limited and where earnings can fluctuate greatly. It would seem unfair for the tax treatment of a self-employed individual's pension contribution to be less generous than that available for an employee. It is also likely to be problematic for the treatment of a self-employed individual's contribution to be different to that for an employee. For many, there will be years where any form of retirement saving is unaffordable, especially where money would be tied up for a period of time, therefore the ability to be able to make larger contributions in the more profitable years is important. Question eight How can the government make sure that any reform of pensions tax relief is sustainable for the future? The pensions 'timebomb' created largely by increased longevity must not be ignored in any changes made. Any changes should build on previous government initiatives designed to ensure adequate saving, rather than being focussed purely on reducing the spend on tax relief. 6
Any change to tax relief should not create a generational gap whereby the next generation simply pay for changes made now. Such as gap already exists given the pay as you go nature of the State Pension. It would be unfortunate if a lack of pension saving now led to an increasing number of people living in poverty in the future and needing greater support from government. Steps must be taken to ensure the less well paid are not only incentivised to save for their future but that this is the default course of action. Any measures taken need to build on the notion of simplicity and helping people to help themselves, primarily by making the default options a safe harbour set by the employer. It is important not to be misled by statistics regarding the amount of tax relief given. Following the 'A day' pension reforms, it should have been expected that higher earners would increase their provision. When the amount that could be paid was restricted by the reduction in the annual allowance, again it should be no surprise that those who are able to do so would maximise their payments in anticipation of further restrictions. Therefore, it is entirely possible that the amount of relief afforded to higher earners is overstated, a trend most likely continued by uncertainty caused by the current debate. What is needed is a thought out plan looking forward fifty years rather than a significant overhaul which may be overturned on a change of government. While it may be hopeful to expect multi-party support for any final recommended measures, the process does need careful consideration and debate which could be aided by a formal review or commission. Sustainability, affordability, fairness and the role of employers should all form a fundamental part of that debate and most importantly, encourage sufficient pension saving. Conclusion Grant Thornton welcomes the debate on the long-term future of pensions within the UK. Given the complexity of the matters addressed above, we very much hope that this is the start of a cohesive and comprehensive strategy that will benefit the country and UK businesses and help individuals to receive good outcomes at retirement. 7
Contacts For any queries in respect of our comments in this document, please contact: Kevin Thorne David Reilly (email: kevin.thorne@uk.gt.com) (email:david.reilly@uk.gt.com) Grant Thornton UK LLP Grant Thornton House Melton Street Euston Square LONDON NW1 2EP Telephone: 020 7383 5100 Fax: 020 7383 4715 www.grant-thornton.co.uk 2015 Grant Thornton UK LLP. All rights reserved. 'Grant Thornton' refers to the brand under which the Grant Thornton member firms provide assurance, tax and advisory services to their clients and/or refers to one or more member firms, as the context requires. Grant Thornton UK LLP is a member firm of Grant Thornton International Ltd (GTIL). GTIL and the member firms are not a worldwide partnership. GTIL and each member firm is a separate legal entity. Services are delivered by the member firms. GTIL does not provide services to clients. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another s acts or omissions. 8