Strengthening the incentive to save: a consultation pensions tax relief Submission to HM Treasury Chartered Institute of Personnel and Development (CIPD) September 2015
Background The CIPD is the professional body for HR and people development. The not-for-profit organisation champions better work and working lives and has been setting the benchmark for excellence in people and organisation development for more than 100 years. It has 140,000 members across the world, provides thought leadership through independent research on the world of work, and offers professional training and accreditation for those working in HR and learning and development. Our membership base is wide, with 60% of our members working in private sector services and manufacturing, 33% working in the public sector and 7% in the not-for-profit sector. In addition, 76% of the FTSE 100 companies have CIPD members at director level. Public policy at the CIPD draws on our extensive research and thought leadership, practical advice and guidance, along with the experience and expertise of our diverse membership, to inform and shape debate, government policy and legislation for the benefit of employees and employers, to improve best practice in the workplace, to promote high standards of work and to represent the interests of our members at the highest level. The CIPD s interest in pensions Within their organisations, many CIPD members have responsibility (sole or shared) for the selection, communication and administration of contract-based defined contribution (DC) pension schemes. Their responsibilities include: selection of the pension scheme; decisions over fees and charges for the default and other funds; transfer of the appropriate HR and payroll data in the format required by the pension provider; educating employees and communicating with them about scheme details and the importance of saving for retirement; helping employees to value and appreciate the employer contribution; and dealing with member queries, as well as directing them to relevant sources of further information, advice and guidance. For our members, workplace pension schemes are an important part of both their employee wellbeing and talent management strategies. That is why around three fifths of pension contributions to DC schemes in the private sector comes from employers. Any proposals to change how pensions in general, and DC pensions in particular, operate will have a significant impact on the value of such schemes in recruiting, retaining, developing,
deploying and exiting staff, as well as on the work opportunities sought by older employees. Any alterations to workplace pension procedures and outcomes will have an influence on how employees perceive the value of saving for their own retirement. Given their responsibility, our members are uniquely placed to understand why employees contribute what they do and how they respond to various pension messages and education. If the government wishes the HR profession to play a significant role in helping their employees save for the future, then it would be wise to listen to their view and opinions. The CIPD s response to this consultation is based on a survey of 115 people management professionals. Most respondents (78%) are HR or reward practitioners, the rest are consultants - either HR generalists or reward specialists - (14%), or are payroll or pension professionals (8%). Most (63%) practitioners work for a large employer, based in the private sector (75%) and operate an open defined-contribution scheme (95%). Some respondents (44%) have a defined benefit plan, but most of their plans are closed to new or future accrual (64%), the ones that are open are focused in the public sector. In addition, we have held a workshop for senior reward professionals to talk about some of the implications from the consultation in more depth and to discuss the responses from the survey. The workshop attracted participation from organisations such as Associated British Foods, Barclays, Thomson Reuters, the London School of Economics and Political Science, Legal and General, Sony and Unipart. In summary, the CIPD s position is: that now is not the time to change the pension tax-system; and an independent commission should be established to make workplace pension policy, so reducing the incentive for policy makers to tinker with the system If the Government has to change the existing tax relief arrangements for pension contributions, the CIPD believes that the following changes would be least unfavourable: there should have one rate of tax relief for all employees rather than TEE, which would reduce employee and employer contributions and be complex to administer; if the lifetime allowance could be scrapped, we would support the annual allowance being brought in line with average earnings the amount of pension that is paid tax-free could be limited; and sufficient time is given to allow stakeholders to update their policies and procedures. Our response to the questions contained in the consultation are as follows:
Response 1. To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension? The consensus amongst survey participants and workshop attendees is that, for most employees, complexity is not an issue. Instead, complexity is typically far more of an issue for higher paid employees, regarding issues such as the annual and lifetime allowances, and the additional rate earners taper tax relief. The belief is that what gets both young employees and low and moderate earners into a workplace defined contribution (DC) pension scheme is automatic enrolment, and what keeps them in it currently is a combination of salary sacrifice and inertia. However, there are concerns that among those employees who have been automatically enrolled at the minimum level, some may opt out subsequently as they are required to contribute more. The extent to which they do so over the coming years will depend on the Government s economic strategy over the next few years, including measures to help boost productivity, thereby increasing real wage growth. When it comes to defined benefit (DB) plans, respondents reported that what attracts and retains this group is that they are seen as a good thing, although some low earners may regard DB contribution rates as an unaffordable luxury. Among older and higher earners, tax relief is seen as driving higher contribution rates. As one respondent notes: Senior and high-paid employees are highly aware and motivated by the current system, although another responded notes: but only if they earn less that 110,000. Other ways of incentivising people to save for their retirement, identified by our reward professionals, include: education and communication; the importance of the employer match; and the recent pension freedom and choice reforms, as one respondent says: The lack of requirement to get an annuity has had some small impact. However, respondents highlight the crucial role that providers and the Government have in supporting pension awareness through workplace financial information, advice and guidance. With regard to communication, employers stress the importance of framing when talking about retirement saving to staff and that, by not joining the pension scheme, they are missing out on free money, especially in those organisations where the employer s
contribution is higher than the employee s. Framing can help encourage employees to increase their contributions. Members also hope that both the new flat-rate state pension and the state pension statement service will encourage employees to think about the best way to save for their old age. 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? It rather depends what is meant by simple. Most reward professionals that the CIPD has surveyed do not think that now is time for TEE. Most believe that it will put many employees in low and moderately paid occupations off from saving as they would have to find the money out of their post-tax, rather than their pre-tax, income. As one respondent noted: Many employees claim not to be able to afford to pay pension contributions. Through our salary exchange scheme, we can demonstrate to them that their contribution level can be quite low and so their take home pay is not greatly reduced. If employees don't get their tax relief NOW, they may be dissuaded from making contributions. Others pointed out the impact on employers. For instance: This would have serious consequence for us as an employer as the cost would be prohibitive to continue the current level of contribution we are making (10% of the basic salary)... If employers cut their DC contributions, then this will reduce the incentive for employees to save through a workplace scheme. Another concern is because employees tend to discount the value of future rewards, it can be hard to help them appreciate the importance of saving for retirement. As a respondent notes: It s difficult for people to feel the value of having a degree of untaxed income in the future verses the tangible effect of saving via tax and NI concessions at the moment. I feel such a proposal will cause people to save less for their retirement.
Those workers who were targeting a certain level of contribution will have to save more under TEE, as has been suggested: Employees who realise they will have to pay more to get the same sized retirement pot will find themselves paying proportionately more tax for their pains. However, others may be put-off due to the additional cost. There is also an element of distrust that the pension rules will change yet again, and that employees could find their pension income subsequently being taxed. I think some employees may not trust a future government not to start taxing retirement income, even though their contributions were taxed, one employer has noted. It has also been pointed out that, for some employees, there is: The risk is that that you pay tax on something that you ll never live to enjoy. If there is no cost benefit for the employer, it has been suggested that some would just contribute the minimum legally required and offer salary instead of a higher pension contribution as the cost would now be the same. Some thought that if there is to be no difference between a pension and an ISA, then employers will wonder why they are being forced to offer a pension when an ISA would do, especially as the ISA could be more attractive for some groups of employees. The only way to encourage employees to lock away their savings for the long term would be to offer some sort of financial inducement for doing so, in addition to the promise that income earned in retirement would be tax free. However, behavioural science indicates that the size of the inducement would have to be significant to get over the myopia bias of valuing the current more than the future. To encourage workers not to reduce the level of their pension savings, the T element of TEE would not be truly T, so adding to the complexity. Members also wonder whether the size of the tax incentive or rebate would vary over time due to government interference. Some are concerned that, under this proposal, the employers would have to contribute even more towards their DB recovery plans, which would lead them to look for cost savings elsewhere, as well as cutting back on business-related investment. As one respondent points out: The changes could lead to some employers reducing their DC contributions and would impact DB recovery plans. Others point out that in the public sector, many DB schemes are PAYG. If public sector worker contributions fell due to the introduction of TEE, then the government would need
to make up the shortfall to fund current pensions in payment, thus increasing its expenditure. While it would be getting more money from the private sector due to TEE, this could increase the feelings (rightly or wrongly) that private sector tax payers are subsidising the retirement plans of public sector staff. Some members believe that tax relief on pension contributions is not actually an incentive to save, but is just a deferral of tax on what would have been paid and the tax on that income should only be paid when an employee is drawing on it. This means that while this arrangement reduces the tax take for the current Government, it does increase the tax take for future governments. However, members recognise that this Government needs revenue now, especially for unforeseen incidents, and so there will need to be limits to how much should be exempted. This means that for some with DC pots the size of EET can differ, for example, little E, big E and little T. The difference between how much an individual saves on their contributions and, ultimately, pays out in tax will depend on their earnings profile and tax policy of successive governments during that employee s working and post working life. In addition, given the increase in the cost of annuities, many employees will not have had a big enough pension pot to buy an annuity that would have put them into the additional tax rate bracket. While the end of the requirement to buy an annuity could push employees into higher tax brackets, depending how much money they drawdown from their fund, it could also mean that they would run out of money before they die and, therefore, fall back on the state. Similarly, no longer being taxed on their pension could result in employees drawing down on their pension pots faster and so running out of money sooner. While there is scepticism amongst our members that TEE will encourage an increase in pension saving, that is nothing compared to the horror they feel at, what they regard, as the increased complexity that this approach will cause. Examples of comments on this increased complexity include: I fail to see how a change to TEE, which will take decades to flow through as past contributions will still have to be treated on the current ETT basis, will do anything except further complicate pensions. I m not sure how easy it would be for HR and payroll systems to move from EET to TEE. I m not sure how easy it would be to work out which part of an employee s retirement income was subject to EET and which to TEE. How on earth are pensions providers going to manage contributions made tax free and contributions that have been taxed? My understanding is that the contributions that were tax free will have to be ring-fenced, and a separate pot will have to be created for contributions that are taxed. And how will pension
income from a pot that is made up of both tax free and taxed contributions be treated when it is paid out? Sounds like an administrative nightmare! While one can t make accurate forecasts yet regarding the extra administrative costs arising from TEE, the CIPD believes that they would be substantial. In addition, it has been noted that TEE isn t British : TEE is more appropriate in countries where there is a higher social security safety net. If we move to TEE, will the government change its approach and increase the size of the state pension to compensate for the shift from EET? Perhaps somewhat cynically, some of our members have questioned whether TEE would be less about encouraging more employees to save more money for their retirement, and more about the Government trying to bolster its finances. 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? While the member opinions regarding TEE ranges from it not being...a good idea to it being a ridiculous idea, they are more supportive of the proposal to have one rate of tax relief on offer to all employees irrespective of their pay, possibly because of their negative reaction to TEE. As one member has noticed: A standard rate of pension tax relief would reflect the reality of what s been going on in the workplace. Over the past 20 years, terms and conditions between management and employees have been harmonised. If employees and managers are in the same company pension, why shouldn t they both get the same tax relief? The government has already harmonised tax relief on childcare vouchers, so why not pension contributions? However, the importance of communication has been noted as being crucial to the success of the flat-rate scheme: If this was communicated well to lower earners it could potentially lead to more saving, but the communication is crucial and if done poorly will have little to no impact. An example would be for every 2 you save, the Government will give you another 1.
Another concern is that, while the tax exempt rate for high-earners would fall, while that for basic tax payers would rise, what would happen to this new rate over time? As one respondent puts it: How would we know that in the future the tax relief on offer would not fall to the basic rate? It would start higher, but not remain there for long. However, respondents also note that while such an approach could (through proper education and communication) boost pension savings for low to moderate earners, it could result in high earners switching their savings from pensions to other savings vehicles, such as buy-to-let. As has been noted, those employees in a DB scheme who have contributed to their plan for a long time do not need to be high earners to be caught by the tax implications from a reduced lifetime allowance. Comments include: If high earners save less through a pension, they ll become less committed to the notion of pension savings and this could accelerate the rate of DB closure. I am already experiencing negative responses to pensions provision from the senior team. The IT and process change costs of recent changes (AE and now the new AA) are distractions from activity and spend in other areas that drive the business. We provide benefits well in excess of statutory requirement, but there is a growing view that this results in unrewarded costs to the business. In the LGPS, higher earners already pay a higher percentage of earnings for the same pension accrual as lower earners who pay a lower percentage. If the tax free element of savings in the scheme is reduced, it would be unfair to charge high earners more for the same accrual rate. Although some noted that: It is unlikely high earners would save less than they would currently do now as the lifetime allowance is so low or Should higher earners choose to reduce their contribution level, they would lose a matching amount of employer contribution, so this should discourage this reaction for many. However, the main concern with having one rate for pension contribution tax relief isn t the adverse impact that this may have on high earners, but the effect that it could have on HR and payroll admin systems. As one respondent notes: This reform would come with an implementation cost and so any change would need to be introduced such that employers have sufficient time to make system changes. While another has pointed out that to be successful:
It would have to be simple for employers to administer otherwise the cost to them would be problematic, especially in the public and not for profit sectors. However, a few are optimistic that while: It is likely to complicate administration, this shouldn t be a barrier to implementing such a system as the technology should be able to cope. While the CIPD is supportive of a flat-rate approach, we believe that we should wait for automatic enrolment to have been rolled out, minimum contribution levels increased and recent pension freedoms to bed in, before we look to change the system again. We would also need stakeholders to be given sufficient time to changes their systems to minimise change costs. 4. Would an alternative system allow individuals to plan better for how they use their savings in retirement? Not necessarily. Our members have stressed that improved financial education and communication in helping employees plan for their retirement, believing that in the shortterm this would be less disruptive than an alternative system. However, there is some debate about whether financial literacy should start in the classroom or in the office. It has been pointed out that learning about pensions at school may be seen as less relevant to pupils as they saw retirement as a faraway eventuality. Also, it would be difficult for teachers, many of whom would have little DC experience, to explain how such schemes worked. As members suggest: Start in schools! Make it easier for people to work out what their income might be worth in retirement through promoting calculator websites and designing something user friendly... Communicate messages about what an adequate amount might be and how to get there e.g. how to work out what saving X a week could turn into at what age, etc. I think there is general ignorance of the benefit of pensions and how they work and it would be really helpful to encourage financial education and a positive promotion of the investment so that people understand how they can maximise their contributions. The education system isn't the right place, it is the individual scheme and what it can offer that needs to be promoted to its members - after all, you want them to remain in the scheme rather than consider taking their money elsewhere.
Communication! Through the workplace yes, but not all employers communicate adequately, and some don't even fully understand it themselves. Simple messaging and impactful advertising could help, word of mouth I have found is the most impactful for converting frivolous spenders to saving for a pension... To part- or full-fund independent advice and encourage all to engage an advisor. Adopting simple, Swedish-style integrated wealth education and communication tools, such as the orange envelope? This perhaps shows the power of affordable (state provided here) joined-up financial data and planning for all. However, as was noted by one employer: Financial education is vital, but it can only ever be part of the solution. So, while financial education is important, it is only going to fully work as part of an integrated financial wellbeing strategy, including such as aspects as a living wage and other risk benefits. Other suggestions include: Stability in pension rules and not making (seemingly) bi-annual changes to the rules. A watertight compact with citizens (and therefore employers) that it is worth them saving for retirement and that this and future Governments won t change the rules in the next 10/20/30 years before retirement. Spreading the tax benefits of pension saving more equitably throughout the workforce. Progressively increasing the minimum contribution levels.., Make it compulsory for individuals to start making contributions to a pension as soon as they begin work, and Remove the opt out. 5. Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated? Most respondents thought that it should not. Among those, however, who thought otherwise:
The lifetime allowance arrangement no longer reflects the value of retirement benefits available from the two types of scheme. It is possible to keep the same lifetime allowance for both but you would need to amend the DB factor to reflect current annuity terms. Currently the tax treatment of DB pensions is considerably more generous than that offered to DC pensions, given that DB pensions have almost completely gone from the private sector, this increases the pensions inequality between state and private sector pensions. 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 barriers that have been highlighted by our sample include: HR and payroll systems would need significant lead-in times to update their software and programmes. HR departments would need time to communicate with, and explain the changes to, their finance departments, incorporate into budgets and communicate with employees. Ideally, pensions advice should be provided as anything that makes pension investments more or less tax efficient might alter how people choose to invest any free income. The more complex the contribution calculation, the more barriers will appear for payroll departments. At the moment, our software can't cope with anything more complex than a percentage of specified pay, auto-escalation would be very difficult to handle. There is a massive variation in the quality and provision in payroll software and the industry would need to step up. HMRC would need to up their game too, RTI still doesn't feel like it has bedded down yet on their side. We spend an extra two days per month on payroll/pension processing since AE was introduced and in addition we also have the cost of the additional pension contributions. Payroll / HR systems are expensive, and not always compatible with 'quirks' of pension systems... Also, HR / Payroll staff are not financial advisors, and often end up with a list of questions that they cannot (logistically or legally answer). Advice costs money.
The problem is that most firms don t regard HR and payroll systems as a priority for investment. As a consequence, the only way they can comply with changing legislation is by spending money in a knee-jerk, ad-hoc, fashion. Until this mind-set changes, reform is always going to be hamstrung. Others were more sceptical about the scale of the administrative barriers, comments included: None, really... it's just coding software, bread and butter work for system providers. Whilst changes would be required, payroll-system providers are used to dealing with annual changes to taxation and therefore this would not be an issue. The administration isn't the issue, the challenge is getting the solution right and then sticking with it for a generation or more. To summarise, the main barriers identified are the costs associated with changing over to a new reformed system and dealing with the member and employee queries that arise because of these changes. One way of reducing the barrier is to give the payroll and HR departments and their providers and advisors plenty of time to amend their existing systems. A rapid change will only increase changeover costs. Once the new solution has been created, politicians should try and restrain themselves from tinkering with it further. Also, change will generate employee queries. To reduce the number, the Government must have a well-funded communications strategy in place to explain to workers what is changing, why and how it could affect them. 7. How should employer pension contributions be treated under any reform of pensions tax relief? Respondents feel that employer pension contributions should be treated as they are now. There are concerns that changing the tax treatment would add extra costs to employers seeking to make good their DB deficit recovery plan. If the tax treatment for DC contributions were changed, then employers may become reluctant to provide more than the minimum required and may be tempted to put their focus on pay and other savings vehicles, which may not support long-term saving in the UK.
8. How can the government make sure that any reform of pensions tax relief is sustainable for the future? Sustainability depends on the economy. Both employees and employers will be able to contribute more to their pension schemes if the country is able to move to a high-wage and high-productivity economy. Government policy should focus on helping employers and employees improving working practices and then sharing the proceeds generated from increased productivity through pay and benefits. The ability of the UK to increase its productivity in the future may be hampered if pension funds have less money to invest in British firms and infrastructure projects because TEE has reduced the amount of money flowing into them. Survey feedback stressed the importance of politicians not changing the pension rules. There is a growing belief among our members that given the long-term nature of pensions policy, it should be taken out of the political arena and given to an independent commission. Though there is a concern that any such commission must be representative of all stakeholders, rather than the usual pension suspects, and that its decisions must be evidence-based. A recent online poll of 800 CIPD members has found that almost three-fifths (58%) think that the Government should leave the existing pension tax relief system as it is. As one respondents has commented, the Government needs:...to let the current system settle. We have had change after change as successive Budgets have tinkered with the tax relief position, pension freedoms, etc. Continual change simply confuses people and costs employers and providers. While another has indicated: The current system incentivises higher earners (and the higher rate is now at a moderate level) to save for retirement whilst AE is getting lower earners into saving. Salary exchange also makes investing in the market seem "safer" as we tell our staff that even when the market drops they haven't lost "their" contribution until the value of ours and the NI saving has been eroded first so the "free money" has given some reassurance to a number of people.
However, if the real objective behind this consultation is to explore ways of saving money (though how much isn t made clear) on pension tax relief, rather than strengthening the incentive to save, then members suggest the following. Reducing: the relief that additional-rate tax-payers can claim the size of the annual allowance to UK average earnings the size of the tax-free element of pension in payment reducing the lifetime allowance indexation having one overall limit for all tax-advantaged savings In summary, the CIPD recommends: that the existing pension tax-system should be left as it is an independent commission should be established to make workplace pension policy: and if the tax system must change: o then we should have one tax relief for all employees rather than TEE, which would reduce employee and employer contributions and be complex to administer o we would prefer the annual allowance being brought in line with average earnings (defined as either the mean, or the median, figure from the ONS s annual survey of hours and earnings), if the lifetime allowance could be scrapped. o the amount of pension that is paid tax-free could be limited o employers, providers and advisors have to be given at least two years to amend their systems in advance of the new system CIPD September 2015