Retirement Advantage response to HM Treasury - Strengthening the incentive to save: a consultation on pension tax relief Overview and Executive Summary It is clear later life in the UK has changed dramatically over the last thirty years and is likely to change even more dramatically over the next thirty years. Many people are living much longer, and increases in average life expectancy for those reaching retirement are likely to continue to grow. Even with later retirement ages and many more people gradually easing themselves into retirement through part-time employment or working for charity, people will spend longer in retirement than their counterparts a few decades ago. In addition, for many people an increasing proportion of later life is being spent in ill-health. This leads to the need for greater and more flexible income to help pay for care in the home, or residential care. Meanwhile the provision for pensions in the UK is rapidly altering. Final salary type pensions which provide the build-up of future benefits are few and far between in the private sector in the UK. They have become the domain solely of public sector employees. Automatic enrolment is gradually increasing the numbers of people saving for their retirement through a pension. However, despite being aided by employer contributions, the overall payments, even when they reach the full level from October 2018, will produce relatively small savings for many. The vast majority of private sector schemes including those used for automatic enrolment are now defined contribution schemes which normally receive lower contribution levels than their defined benefit counterparts, and also mean workers take on all of the risk in terms of investment and rising life expectancy. This combination of more people needing retirement income for a longer period and having to fund care costs, together with the lower provision engendered by the move to defined contribution schemes, means there is a huge need to encourage greater pension saving. Your consultation outlines a variety of ways in which pension tax relief can be altered. We believe there are a number of key elements which must be considered when any decision is taken
1. A focus on encouraging more people to save more: It is crucial any change to pension tax relief is taken with the primary aim of encouraging more people to save more. While there is a huge attraction in using savings generated from pension tax relief to help reduce the UK deficit, this cannot be the focus. Getting more people to save sufficient amounts to provide for their retirement is of huge importance to the future wellbeing of our country and must be the key objective. 2. A measured and considered approach: Any change to pension tax relief needs to be made in a measured and considered way and not rushed onto the statute book. As fundamental change as this needs cross-party consensus and ideally should last a generation, not be ripe for change in a few short years. Confidence in pensions has not been helped by the continuous change we have seen over the last decade. Change which has no consistency, no well thought through end game just change year upon year. Pensions are a long-term savings plan, and need a long-term commitment from politicians. 3. A simple easy-to-understand system: Pensions are enormously, and unnecessarily, complicated. It can be argued that the current system of tax relief isn t understood by enough people and doesn t sufficiently incentivise younger and less well-off savers. However we also need to remove ancillary rules such as current, unnecessary, lifetime allowance, and the horribly complex tiered annual allowance. We need one system covering all types of pensions, including defined benefit and defined contribution provision. A customer would say they have a pension (not the specifics of what type) and as such all pensions should operate in the same way as much as possible. However, simplicity is not inherent in any one system, rather it is key that the communication surrounding pension tax relief simply and clearly demonstrates the value which it delivers to savers. 4. Incentives for employees to save: Locking money away for retirement doesn t come naturally to many people. There are numerous financial demands on people s money, and many behavioural studies demonstrate that spending to gain immediate gratification is easier than overcoming psychological barriers and locking money away until an unknown and for many unimaginable - future date. So it is crucial there are clear incentives to push people to save for their retirement. These incentives need to be clear and simple for people to understand. But, more importantly, people have to have trust. If people believe a future Government could fundamentally change the system and reduce or remove an incentive then they will lose trust, and not save as much. 5. To make life easy for employers: If we want to help more people save more money for their retirement then employers are key. It is by building on payments from their employer that people really build up decent retirement 2 P a g e
savings. So it is vital that as well as considering changing tax relief for individuals, we encourage and incentivise employer payments. And remove as much red tape as possible setting up and paying into a pension scheme for employees should be a simple straightforward task, not a herculean effort. Our conclusion Some believe an ISA-style system will be simpler for people to understand. However, if this means losing upfront tax relief, it is highly debatable if it would encourage more saving. It s also difficult to see how defined benefit schemes could be shoe-horned into an ISA-system, leading to the possibility of a different method of tax relief for DB and DC. That would seem hugely unfair. And, as significant tax relief goes towards DB schemes, it would also limit the tax savings which Government would make. However, it can be argued that the current system of tax relief isn t understood by enough people and doesn t sufficiently incentivise younger and less well-off savers. Add in the complexity of continuous changes to limits such as the lifetime allowance and annual allowance, and the system is ripe for change. Therefore, we believe change is necessary and our preference is to amend the current system by moving to a flat-rate of tax relief for all particularly if it can be presented simply, along the lines of you save 2 the Government adds 1. Tax relief that gives a clear incentive to save, especially for those who don t currently save enough, and is easily understood. Combine this with the abolition of the current, unnecessary, lifetime allowance and tiered annual allowance and introduce further help for employers to encourage them to pay as much as possible as that is fundamental to decent savings and we have the beginnings of some simplification. However, it is crucial significant research and thought is put into any change with a cross-party commitment to limit future changes to pensions. And time needs to be taken to develop a well thought through communication plan, in advance of any change being made, which aims to highlight the benefits of pension savings to consumers in a simple and effective way. 3 P a g e
Retirement Advantage response to specific consultation questions 1. To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension? There is no doubt that pension legislation is too complex. And continual changes to the system which make it increasingly difficult for people retain knowledge or have trust in the system make matters worse. Trust is a fundamental issue, and unless people have trust that their money will be safe and they understand the benefits which they get in return for locking their money away, many will shy away. But it is not just the system that matters, it is the way in which that system is communicated to people. If we devise a simple way to communicate tax relief, then the underlying complexity will not be as significant an issue. A move to a flat-rate tax relief gives the option to communicate tax relief along the lines of you save 2, the Government adds 1. This is a simple message, which is easier for people to understand. And as extra money is added to their pension pot immediately, they can have trust that a benefit has been given to them which is unlikely to be removed. Whatever system is put in place whether it is the status quo, a flat rate of tax relief, a move to an ISA-style system, or some other option the communication of the tax relief available to people is a key component. There needs to be a coherent, clear and simple communication of the benefits of saving in a pension, and the tax benefits which that saving provides. The Government should devise and lead this communication strategy. 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 into a pension? A simple system, in itself, will not encourage more people to save. It may remove some barriers to saving, but we still need to incentivise people to lock their money away for retirement. And give them trust that the incentive won t be removed, or watered down, by a future government. It is likely many people would see an ISA-style system, where no tax relief is given up front, but people are told they will be able to access all funds tax-free at retirement, as unreliable. It would be very simple for a future government to impose a tax charge in retirement, and therefore break the deal. And given the numerous changes we have seen to pensions over the last 10 years, with annual and lifetime allowances reducing dramatically, it could be viewed as a likely scenario. 4 P a g e
Therefore we believe the system which would engender the most trust among people, and remove the most barriers to saving, would be giving some form of tax relief upfront, which is tangible and understandable. A move to a flat-rate tax relief is, we believe, most likely to encourage more saving amongst lower-paid and younger workers, especially if this can be communicated in a simple, straightforward manner. A flat-rate system of tax would still be attractive to higher rate taxpayers. Many higher rate taxpayers will pay basic rate tax in their retirement so would pay a lower level of tax on income than they had received on contributions. For those who continue to pay higher rate tax in retirement, 25% of any pension pot is available taxfree. Therefore, even if they pay 40% tax on all of their pension income, overall their effective tax rate is 30%, which would be lower than a flat-rate tax relief of 33%, providing these people with some incentive, in addition to the tax-advantage growth they achieve with the fund, and the benefit of employer contributions. 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? A huge number of people approaching retirement are ill-prepared. They lack knowledge and lose out significantly as a result. They don t understand how much they need to save, when is the best time to take benefits, the tax consequences of their actions or the ideal way to provide a sustainable income for their retirement. Therefore an alternative system will not, on its own, encourage more people to save, or help them save appropriate amounts. It may remove some barriers to saving, but we need to work much harder at educating people and helping them prepare for their retirement much earlier in life. Partly in terms of saving more, but also in terms of understanding the options available to them and the ways in which they can find help and assistance when making decisions. 4. Would an alternative system allow individuals to plan better for how they use their savings in retirement? No, in itself a system of tax relief does not drive a better outcome. We need much greater education and awareness of the importance of pension saving, highlighting increasing longevity and the need to pay for care in later life. Alongside this, we need to encourage (and incentivise) higher pension payments from both individuals and their employers, starting as early in working life as possible. It is by making some payments for as long a period as possible and building on the bedrock which is provided by employers that people will start to obtain decent retirement savings. 5 P a g e
A move to an ISA-style tax, exempt, exempt system would also create confusion and increase costs by requiring two separate systems to be run alongside each other for a generation. Many people would have savings with the current upfront tax relief system which would need to be ring-fenced and taxed as income when taken. Meanwhile new savings would be held in a separate arrangement and be tax-free at retirement. This may well cause greater confusion amongst people about the size of the pot they need at retirement compared to the savings they actually have. It will also increase industry costs which would inevitably be passed onto consumers. 5. Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated? No. If you ask a customer, they will simply say they have a pension. People do not differentiate, nor should they be forced to, about the intricacies of different types of pension legislation. We need to simplify pensions and therefore all pensions should operate in the same way as much as possible. An additional point is the vast majority of open defined benefit schemes, where people are building-up future benefits, are in the public sector. That means there is already a huge disparity between the pension benefits being provided to people doing similar jobs, but where one works in the public sector and one in the private sector. Any further changes to exacerbate this significant gap would seem unfair and would likely to be very unpopular with private sector employees. 6. What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How could these best be overcome? The pension tax system is complex, so there are many changes that would need to be made if pension tax relief was altered. There are two systems of providing tax relief for employees the net pay arrangement where employers deduct employee payments before tax is calculated. And relief at source where the pension scheme administrator claims basic rate tax relief from HM Revenue and Customs and adds it to the member s pension pot. Any higher rate relief is then sorted directly between the individual and HMRC. Any move to a flat-rate system of tax relief will mean changes to the way these systems operate, especially the net pay arrangement. Changes to the net pay arrangement would also involve significant amendments to employer payroll software. Moving all pension schemes to a relief at source basis may be a simpler option. A move to an ISA-style system would require pension providers and pension schemes to maintain two separate systems for a generation. Many people would have savings 6 P a g e
with the current upfront tax relief system which would need to be ring-fenced and taxed as income when taken. Meanwhile new savings would be held in a separate arrangement and be tax-free at retirement. This would greatly increase costs and complexity. And make communication with customers even more difficult. Whatever decision is taken regarding tax relief, this confirms Government cannot rush into a quick decision. Any change needs to be made in a measured and considered way, with thought and planning given to the obstacles to change and how best to overcome these. Then allowing the pensions industry, employers and workers a period of time to adjust, and make necessary changes to systems and documentation. In that way, communication of any change can be made in a planned way, and not rushed, much increasing the likelihood of greater understanding, and helping to achieve the overall objective of greater pension saving. 7. How should employer pension contributions be treated under any reform of pensions tax relief? Employers are fundamental to encouraging and providing greater levels of pension saving. It is remarkable that many employees opt-out of their employer s pension scheme, effectively turning down free money. This demonstrates the need for much greater education and communication by government. But also highlights the need to make life easy for employers. It is by building on payments from their employer that people really build up decent retirement savings. So it is vital that as well as simplifying tax relief for individuals, we encourage and incentivise employer payments, by continuing to allow employer contributions to be offset against Corporation Tax, and be exempt from employer National Insurance. And remove as much red tape as possible setting up and paying into a pension scheme for employees should be a simple straightforward task, not a herculean effort. 8. How can the government make sure that any reform of pensions tax relief is sustainable for the future? It is vital any new system stands the test of time. If we want to engender greater trust in pensions, and encourage more people to save more for their retirement, then we need a robust, trustworthy and simple pension system. From a political perspective that means taking time to get changes right, not rushing to introduce a change as soon as possible. And also, crucially, taking time to devise and develop a comprehensive communication strategy so that clear, accurate messages are given to people as and when any changes are announced. Too often in the past we have seen a change made, with limited information given at outset, which is then changed and developed over a period of time. Examples would include changes to women s state pension age, 7 P a g e
and the introduction of the flat-rate state pension. This partial and gradual communication results in an unhappy public who believed one thing was being introduced when, in fact, something slightly different was happening. Cross-party support for any change is also key. Any change needs to be supported by all parties, so that it can last for a generation. Pensions are long-term savings plans and need a long-term commitment from politicians across all parties. This then allows people to save with confidence. About Retirement Advantage Previously known as MGM Advantage and Stonehaven, we are a well-established company that can trace its roots back over 150 years. In 2015 we changed our name to Retirement Advantage merging our retirement income and equity release divisions, to help us provide those who are in, or approaching, retirement with a range of simple, secure and flexible products to suit their needs. We are one of the fastest growing businesses in our sector, with over 1.7 billion of funds under management and thousands of retirees relying on us for their income. Contact Andrew Tully, Pensions Technical Director, Retirement Advantage andrew.tully@retirementadvantage.com 07766 231 730 www.retirementadvantage.com 8 P a g e