The TUC was one of the sponsors of a new report on pensions out this week. I need to give this issue some more attention again, but one matter highlighted jumped out:
Basic rate taxpayers make more than half of total pension contributions in the UK, but receive less than a third of pensions tax relief expenditure. More than half of expenditure goes to higher rate taxpayers, and 17 per cent to additional rate taxpayers, but these groups make only 37 per cent and 9 per cent of total contributions respectively.
Try as I might I can see no justification at all for subsidising the savings of the rich at a higher rate than the savings of those on lower income. The time for higher rate tax relief on pensions has long gone. A courageous government would say so, now.
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Agreed. You would think that higher-rate taxpayers would be better placed to make adequate pension provisions than standard-rate payers, so if anything they should receive less relief. In fact, I’m not at all convinced there’s a case for any pension tax relief for anyone…..
Oldcobbler ,
If you are going to tax the money on the way in , then presumably you would have to stop tax the money on the way out .
That would work fine for people with a defined contribution scheme but how are you going to determine what the tax relief should be for workers who are enrolled in a defined-benefit scheme ?
Certainly in the case of those state sector defined benefits schemes which are pay as you go rather than based on a fund the temptation will be to continue to understate the value of the accrued benefits in order to reduce employment tax paid .
When the contributions for defined benefits pensions have to rise to cover deficits people will end up having to pay more tax .
Perhaps 100% tax relief should remain for state and private sector workers until the state actually offers everyone access to a decent pension ?
The “group of 40” Tory MPs even agree with that, so let’s hope it happens.
Gary ,
Why would an MP or for that matter any state sector worker in receipt of a defined benefit pension guaranteed by the masses care if other people have tax relief on pensions contributions reduced ?
We have a situation where the state worker and their employer probably only have to pay less than half the actual and notional contributions respectively that someone with a defined contribution scheme and their employer would have to pay for a similar level of benefit .
The understatement of the value of state sector pensions benefits also leads to an understatement of the tax-relief state sector workers enjoy .
Many state workers on quite modest gross salaries would be in the higher rate tax band if the value of the pensions benefits they accrue was properly stated .
What Richard says about the tax relief basically being almost equal to private pensions payouts is a revealing insight and yes it looks like the industry is perpetrating a confidence trick . Thanks for the insight Richard .
Why shouldn’t National Savings be required to offer everyone else the same level of inflation linked notional investment return that state sector workers have access to ?
It’s time the state took responsibility for a much improved primary state pension and an earnings related vocations scheme open to everyone .
Either state sector vocational pensions schemes should be opened up to everyone or state sector workers should be enrolled in NEST , the scheme they devised for everyone else .
In May last year I wrote to HM Treasury suggesting that it would benefit both the fiscus and the BR tax payer to have a flat rate of 30% on pension contributions. In his reply to me, John Stanton, of HMRC’s Ministerial Correspondence Unit, told me that consultation with the pension industry and employers identified that trying to restrict the rate of tax relief in the way I suggested would be ” unduly complex and burdensome”. So there we have it.
I’d have said 20% and then it would have been glaringly easy – that’s done at source entiely in that case (OK, bar old style RAPs)
One of the main arguments for tax relief on contributions to pensions is that pensions are taxed when they are paid. If you offer partial tax relief on funds paid in, then would you also favour partial taxation on the funds paid out?
If you restrict the tax relief on contributions then there is the very real possibility that an individual will pay in funds and receive basic rate relief (20%) and then pay higher rate taxes (40%) on pension income received at the other end. I am sure I can’t be alone in thinking that would make pensions rather an unattractive proposition as the combined tax position is higher than the highest rates of income tax.
I would suggest that if you restrict relief to the basic rate on contributions, you need to consider limiting the rate of tax paid on pensions received. This should raise revenue because people generally pay a higher rate of tax during their working lives and the government would bring forward collection of the tax.
This sounds rather simple, but the whole thing becomes quite complex when you realise that there will (hopefully) be income and gains within the pension on which full tax relief has been granted (could these receive only basic rate relief as well?) and there will be people that have already saved for a pension with full income tax relief (could those parts of the contributions they have made be excluded from a reduced rate of income tax on pensions?).
I really do not think a 20% life time rate and 40% pension rate is anything but very remotely likely
Shall we make comment about the real world, please?
And no – there is no need to limit the tax rate on pensions – just as we don’t on cash savings which get no tax relief at all when deposited. Again, shall we talk about reality, not a fiction?
I am not sure if you misunderstood the comment, if a higher rate tax payer receives basic rate relief then they will have paid 20% tax on funds contributed. It is quite possible for that individual to be a higher rate taxpayer that pays 40% tax on their pension. This is an entirely real world possibility and we know these people exist because the press has been full of complaints about higher rate pensioners receiving winter fuel allowances etc.
The difference between a pension and a cash deposit is that the bank doesn’t tax you when you draw your capital out, they only tax the interest you earn on that capital.
Your proposal would leave the funds partially taxed on the way in and fully taxed on the way out.
Yes
That’s the plan
Partially taxed is still a subsidy
For most people who make contributions to defined benefits pensions , I doubt that an inflation linked annuity will even pay out enough to raise the income they get from state pension above their personal tax free annual allowance or disqualify them from means tested benefits .
From what I can see the only benefits for most people including those not far into the 40% bracket are that i) even if they are ill disciplined they can’t get at the money ii) a pension is difficult for your creditors to get if you are declared bankrupt .
I stopped paying in to my SIPP because my health mean’s an insurance policy of living longer than my savings is not the best answer for me .
Is even 3% annualised growth achievable on a low risk defined contribution pension fund over an entire working life ? Comparing the P/E ratio’s of blue chips and inflation rates I’m not sure that it is .
Then when you come to cash in your lump sum you have got a derisory annuity rate !
For illustrative purposes , what range of investment performances above/below inflation and net of charges should salesman be required to give prospective customers of a private pension plan ?
My understanding is that most office workers reach peak earnings capability at about age 40 and that their earnings capability diminishes by age 50 .
Pensions savings up until to age 40 which have the longest to grow if investment performance is positive (and the longest to shrink if it is negative) will likely be derived from earnings in the standard rate tax band .
The issue of tax relief seems to be a distraction from the much larger problem of lack of access to a decent pension scheme and people reaching retirement age with no savings and maybe even debts still .
How long will we have to wait for the state to :-
– pay a livable state pension ?
– offer secondary pensions to everyone which are equally generous as those it offers to it’s own workers ?
Is there any chance of even the first one ever happening ?
I have realised my comment was maybe not entirely clear, when I said partially taxed on the way in, and fully taxed on the way out. I actually meant partially taxed on the way in and then fully taxed all over again (as though it had never been taxed) on the way out.
Partially taxing something isn’t a subsidy if you tax the whole amount as income the next time you see it and consequently create double taxation in the process. It would be strange indeed if paying into a pension was a way to give governmental control to your savings, subject yourself to a significant amount of regulation as to what you did with the money and the best you could hope for would be to end up paying just as much tax as if you hadn’t gone through the process in the first place, with the worst position being that you pay considerably more. I think we can safely say few people would voluntarily put money into pensions and the state would pick up the bill in due course.
Higher rate tax payers could use an ISA safe in the knowledge that they have nothing to pay later and no governmental control over their savings.
I note Striebs comments about the returns on pensions already being poor enough that they aren’t necessarily attractive.
Why is it strange that savings may be taxed?
That is what pensions are
The question is whether they are the right way of going forward now – and why some need so much higher a rate of subsidy
“It would be strange indeed if paying into a pension was a way to give governmental control to your savings”
That is EXACTLY what you are doing when you pay any money in to a pension . The Govt knows precisely where to find it and you cannot remove it .
They already use it as if it’s their own money by instructing pensions funds to buy certain types of assets . What is to stop them just doing an Argentina , look at what the EU did to Cypriot savers after they had given the big guys time to get their money out .
We desperately need a separate independent state body to act as trustee of assets and administrate pensions schemes (possibly in conjunction with the Government Actuaries Department) .
The Govt of the day cannot be trusted with assets or pensions .
Pensions are savings, and there is nothing strange about taxing savings, but I wouldn’t put a pound of taxed income into a bank if I thought I would be charged 40% tax on any withdrawal from the account.
It is perhaps easiest to illustrate the position with a simple example, you have three taxpayers in identical positions, all are well heeled higher rate tax payers with pensions that will ultimately result in higher rate taxes being paid and all are due to retire in a years time.
Taxpayer 1 puts £600 into his pension, which is basically matched by a contribution of £200 (ie restricted to basic rate relief under your suggestion). I won’t worry about the precise mechanics but suffice to say he now has £800 in his pension. That income grows at a rate of 3% over the year, bringing it to £824. He might not be able to access those funds easily, but if he was able to using a draw down pension he would receive £824 which would be taxed at 40%, leaving him with £494.40
Taxpayer 2 puts £600 into his bank account and receives 3% which is also taxed at a rate of 40%. He pays his £7.20 in additional tax and at the end of the year is able to draw £610.80 out of his bank account without any issues at all.
Taxpayer 3 puts £600 into his ISA and receives 3% which isn’t taxed at all. He could now draw £618 out of his ISA without any tax being due.
Taxpayer 4 put £600 into his pension under the existing scheme and receives an additional £400, bringing his pension to £1000. He receives interest during the year of 3% bringing the pension to £1030 and draws it down in the same way as taxpayer 1. He is left with £618 (identical to the ISA position).
I don’t think you will find many people that will willingly step into the shoes of Taxpayer 1.
Admittedly 1 year is perhaps a little short term, so we could perhaps revise it and look at 10 years at a compound rate of 3% per year.
Taxpayer 1 now ends up with £645.08, taxpayer 2 ends up with £717.18, taxpayer 3 ends up with £806.35 and taxpayer 4 ends up with £806.35
It is clearly the case that the person with an ISA will always do better than the person using a pension under your proposal and no better or worse than a person receiving full relief on a pension contribution. The person using a pension under your proposal might beat the person using the bank account, but only after a substantial number of years. If you are getting a return of around 3% per year it would take almost 20 years to end up better off than the person with the bank account.
I am sure there is an argument that the tax advantages of an ISA are far too good, but even ignoring that a pension isn’t going to be popular if it can’t beat a bank account. I haven’t bothered to suggest the idea that the same funds could have been invested in some sort of unit trust aimed at capital growth which is taxed at lower rates and could be left to roll up tax free until the gain crystalises allowing better compound growth. In fact the pension is more likely to be invested in that kind of thing anyway.
I think we can safely say the rich just wouldn’t bother to have pensions at all, so that might achieve your goal one way or another.
But let’s be clear about this: private sector pensions do0n’t work bar tax relief
Read here http://www.financeforthefuture.com/MakingPensionsWork.pdf
Now why are you so keen on a state subsidised failing industry?
Strangely enough I am not keen on pensions at all. I don’t have one and I don’t want one. I just like to work through the practical implications of any ideas.
I agree that if it wasn’t for the tax incentives offered pensions wouldn’t have any support. I would pick an ISA over a private pension every time. Why any individual would want to save using a highly regulated scheme when there is a barely regulated alternative with identical tax results is beyond me. Of course the government has taken steps to prop up these schemes by forcing employers to pay into them as well as employees, which may be the only other reason for their existence in the future.
“But let’s be clear about this: private sector pensions do0n’t work bar tax relief”
Isn’t that comparing the outflows from pensions in payment with inflows into new pension savings?
If so, then it’s horribly misleading. Far more people are now paying into new private pensions than were in the past.. so it’s not a valid comparison. There’s enough wrong with the pensions industry without having to resort to junk science. If the only money coming out was the tax relief that went in, then there would, necessarily, have to be 60-80% capital loss across the board. If that was happening then someone else would have mentioned it.
Actually – doesn’t that make the situation even worse?
Lee T ,
I’ve always warmed to the idea that pensions , and other systems , should be demographically neutral .
It seems that the Office for Budget Responsibility really has told Westminster that the country needs 6 million more immigrants to fill a hole in future finances created by an aging population .
The O.B.R. struck me as a good idea in principle but suspicions lingered given the word “responsibility” had to be explicitly included in the name as it reminded me of the South African “Truth and Reconciliation Commission” .
If the private pension system is essentially paying current pensioners out of the tax relief on current workers contributions then the scheme isn’t demographically neutral .
If as you point out it actually requires an ever increasing number of new members , or level of contribution then it meets the classic definition of a ponzi scheme .
“Actually — doesn’t that make the situation even worse?”
I’m afraid I don’t follow.
It’s fine to say that the tax relief/deferral for pensions is the main reason they work. But that’s the whole point of pensions as a savings structure, so it’s not really a criticism (unless I’m to criticis Lionel Messi for only working as a footballer because he’s got a football). I’m OK with criticisng the returns achieved by the pension industry (or, rather, the amount of money they skim of those returns for themselves) but I’m not going to bash them for failing to ‘match’ the contribution of tax relief.. because a 20%/40% capital bump on day 1 is a tall order. Only the state can do that, because only the state can take the 20%/40% in the first place.
What’s not fine, is taking the value of payments to 100 current private pensioners, and comparing it to the tax relief granted to 500 younger people saving for their future pensions, and concluding that the numbers are the same and therefore all private pension payments are funded by tax relief. They are not. The pensions in payment are funded by the total of contributions, investment performance and tax relief over the lives of the recipients. The tax relief being granted now is for a completely different, and much larger, group of people.
It’s not that the cashflows are not linked. Current savers need to pay into schemes so that current pensioners can realise the value they have accrued. It’s just that there’s an awful lot more money going in than just the tax relief (at most, it can only be 40% of any given contribution).
Forgive me for not going and getting the actual numbers, and for the obvious oversimplified nature of my illustration (and my ignoring the impact of tax-free lump sums, which is not inconsequential).. but say you had £35bn of private pensions in payment, and £35bn of tax relief for current savers..
This means that current savers are actually putting away something like $100bn, including their tax relief. When they finally draw that $100bn out they will be taxed (say, at basic rate) so there’s £20bn that the state will get back. In cashflow terms, that deferral of taxation is partly offset by the £7bn in tax that the current pensioners will pay, as their own deferral unwinds.
The correct comparison would be the eventual £15bn net cost of the tax relief granted to the current savers, with the $100bn that is going to be paid out to them.
Assuming the same basis, the $35bn being paid out to current pensioners would only have ‘cost’ $7bn in tax relief, with the majority coming from the ee/er contributions and the investment performance.
Tax relief only costs the difference between the marginal rates at the time of contribution and the time of withdrawl, plus the time value of deferring reciept of whatever tax ultimately is collected. We can offset this with the additional tax on the pension if the value of the fund grows (as they usually do over the long term) though the converse is a risk.
The troubling thing is, this is simple stuff which you obviously understand. Hence, the assertion made in the report bothers me. We share a lot of common ground with regards to the world of pensions (both how it is, and how it ought to be), so I’m not mounting a defence of private pensions or picking a fight. It’s just a seriously flawed calculation.
I note your claims
I do not agree them and have explained why already
@ Striebs
“If as you point out it actually requires an ever increasing number of new members , or level of contribution then it meets the classic definition of a ponzi scheme.”
I didn’t say that it ‘requires’ an ever increasing number of new members. I pointed out that there are a lot more private pension contributors than there are private pension recipients. That’s because of the huge changes in pension provision over the past 20/30 years. There’s no reason why the system would break down if the ratio moved one way or another.
That said, the Ponzi comment isn’t entirely without foundation. However, all pensions work like that. The state pension is paid out of current taxation, so it relies on an every increasing number of taxpayers. The much-discussed public sector pensions are either unfunded (i.e. current members are paying the contributions of retired members) or are funded (in which case they are no different to private pensions, which are, by their very definition, funded.. but still reliant on future economic activity).
By your reasoning, Private pensions are a bit Ponzi, and state pensions are entirely Ponzi. Except that, in both cases, the intention is that the contributions/taxes are invested in a manner which ensures that, unlike in a Ponzi scheme, there are genuine returns with which to pay the future benefits.
I think I recall exactly why I said you should not comment last time
Can I remind you that I can revive the decision at any time?
“I think I recall exactly why I said you should not comment last time”
Richard.. You have not made any counter to a single point that I have made. Not one. You say you’ve explained something, but dont give a clue as to where. You say you disagree, but don’t give a specific example of something disagree with, let alone any explanation of why. Given that this is all about matters of fact/methodology, not matters of policy, I don’t get it.
I decided I should not comment here, not you. You’ve always got your veto, and may wield it as you wish.
http://www.financeforthefuture.com/MakingPensionsWork.pdf
Michael ,
When you mentioned £600 pensions contributions I presume you meant £600/month i.e. £7,200/yr .
Given that life expectancies indicate 20+ years in retirement such a contribution is reasonable but I reckon most people on the street would struggle to get their head round it .
The important thing would seem to be the way the money is spent – on acquiring assets and future income .
I am assuming these well heeled individuals will go for income drawdown rather than buying an annuity because that is easier to illustrate without needing to worry about any other complexities.
I picked £600 because it is the amount you get out of £1,000 after paying higher rate tax. It is just an easy number to use in an illustration. I wasn’t worrying about how often somebody was putting in £600, it was just intended to show what would happen to every £1,000 of untaxed income.
The calculation is perhaps a little too simplistic to show what would happen in every possible circumstance. Every individual that is likely to be a higher rate tax payer in retirement would need to work out their own position based on various choices. The full calculation would be rather too complex to present here and involve rather too many assumptions.
Pensions are deducted from taxable income and so the tax saved by an individual paying £100 into a pension might be £20, £40 or £45 depending on their top rate of tax. This is reported as some sort of subsidy for the rich but the exchequer is not GIVING anything to the taxpayer, simply not taking something away.
If the logic that it was somehow ‘unfair’ that a higher rate taxpayer ‘saves’ more were true why doesn’t it apply to all deductions from taxable income?
Suppose a 20% self-employed taxpayer has his 100% business-use car serviced for £200. His tax-bill would have been £40 higher had he not. Compare that to a 45% self-employed taxpayer. The same scenario would result in his tax bill being reduced by £90.
Would you seek to argue that the higher-rate taxpayer is £50 ‘better off’ and that this is unfair?
Should all deductions from taxable income be restricted to a basic rate relief?
But there is no God given right to such deductions
They were maybe the right policy choices at one time
They’re not now
And a basic rate releif only now might well make sense is what I am saying
And all the while, the pensions industry gets away with appalling returns on pension funds, while making sure of course that they take their annual cut, and, while annuity rates are an essential component of what pensions can be paid, come up with pensions that require people to live into their nineties, way past average (mean?) life expectancy, to recover the value of their pension savings. Perhaps, if the pension industry was encouraged/forced to play fair with its pension investors, taxing pensions, with which I agree, wouldn’t be such a big issue
Pension contributions should be considered as deferred wages, not savings, and could be provided much more efficiently by the ‘state’ There would be no gambling/speculation in non-productive assets and no creaming off by the finance sector. Any further saving for retirement should not be tax exempt.
Bring back SERPS.
I have to say I have very strong sympathy with that
Carol , Richard ,
Sorry but I do not buy the claim that a pension is “deferred wages” .
– For a start that would imply a closer relationship between what one did during one’s working life (or at least service to a specific company) than to longevity ….
… unless pensions payouts used a discount rate to decide how much to pay out .
Instead I proffer that pensions are an insurance policy against old age – i.e. that the majority will pay slightly more than what they withdraw but the minority who exceed their life expectancy (and would otherwise exhaust their savings) are kept in tolerable lifestyle .
Even as a life limited adult that is the way I think pensions should be – insurance – and national insurance is the best insurance of all .
I do however completely agree that pensions are best provided by the state and would add that the job of employers is to concentrate on what they do best and pay the going rate for the job at that time (as best they can) .
The job of the state should be to deduct whatever is necessary for that person’s old age .
Furthermore , only a tiny percentage of the companies which one works for will even be in existence in any form by the time one retires .
Just to summarise , “pensions contributions should be considered as deferred wages” sounds superduper but for the aforementioned reasons I don’t think it is correct – or even a desirable way of looking at it – and I think the Unions should stop describing a pension as such .
Insurance is for something which may happen – a risk. Getting old and being unable to work is not a risk.
BTW, I agree with Striebs: “We desperately need a separate independent state body to act as trustee of assets and administrate pensions schemes”.
Michael
In your comparison between Isas and pensions you need to allow for the 25% tax free Pension Commencement Lump Sum.
An excellent point, and I concede that would make the return on a pension better than an ISA and reduce the amount of time before a pension did as well as a bank account. I can see the need to build a bigger more accurate model!