I am intrigued by some early responses to ‘Making Pensions Work’ I have received on this blog and have read in some (typically abusive) commentary on the right wing blogosphere to which I do not link.
Without exception the commentary ducks the issue, which I find fascinating. The key issues that raises are:
1. The private pension sector has received a subsidy of £300bn a year over a decade and has appeared to lose it;
2. The private pension industry pays out less in pensions each year than the state subsidy it receives;
3. The assets in which the pension industry chooses to invest do not reflect the fundamental pension contract.
4. Many of the assets in which it has invested have persistently generated negative rates of return, despite which its investment behaviour has not changed.
5. The choice of investment it has made has resulted in speculative saving activity as the core focus of pension fund management when the economy has required investment to stimulate new economic activity, employment and innovation to tackle the real issues we face as a society.
It is these issues that motivated the recommendations made in ‘Making Pensions Work’. But the concerns raised have been along the following lines (with the challenge in italics and the response in plain text):
a. The proposal to redirect investment into productive activity will deny financial markets essential liquidity. But is it the states job to subsidies the liquidity at cost to future pensioners, is my response? And if this market cannot generate such liquidity itself why should we give it the biggest state subsidy any industry has ever received in the UK to overcome its structural defects? Shouldn’t the market resolve that defect itself?
b. The rate of return is not so bad. What? 1% before allowing for inflation and after receiving a massive state subsidy is not so bad? By this definition, what is bad? I am suggesting something better.
c. I'm promoting a massive private equity bonanza. No I’m not. I’m promoting investment in new economic activity. The fact that those making this comment think this only arises through private equity venture capital investment is itself significant: they’re saying in effect that the larger quoted companies in the UK are actually unrelated in terms of their capital funding to the stock markets that supposedly serve their needs but which in reality act as casinos for speculation. And anyway, much of this money will go into government bonds and related products. So this is wrong.
d. I’m breaching EU rules on capital mobility. No I’m not. There is a long history of UK tax reliefs being available for UK investment only. But if the investment base has to be broadened — so what? In marketing terms I am sure that the offerings made available will actually be UK based if the transparency I am seeking is also made available. The market will solve this problem.
e. Pensions are just income deferral. So is interest on that basis on a deposit account. But it does not deserve and does not get tax relief. Pensions are not deferred income. They are saving for old age. That’s it. If we are to subsidise the saving of the best off then we have a right to attach conditions.
But I note there has been no attempt to justify the subsidy.
Or to defend the obvious failure of this market.
Or to explain why half the deficit at the start of this crisis related to subsidies to pensions in the previous decade.
Because, I suspect these are indefensible.
This issue will, I suspect, begin to grow. Give it three years and I think this issue will be a major item on the UK political agenda — even a key focus for the next election. And hwy not when it is so important?
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
You grossly underestimate the cost of private sector pensions: govt figures show it to be actually about £50bn., not £38bn. Also, the key point is that contributions to the state pension that everyone gets do not attract tax relief, whereas contributions to rich people’s pensions (i.e. private sector sector pensions)do attract tax relief. In addition the people who RELY on state pensions cannot retire early, and probably haven’t benefited from subsidies for tertiary (or even secondary) education and are likely to have to do paid work for 10-15 years longer than the lucky sods who have private pensions. Private pensions are quite unlikely to be paid in large amounts to women who’ve done most of the unpaid work of society – historically, they couldn’t afford to put enough time into their jobs to earn enough to build them up.
About a year ago, I got Patience Wheatcroft, Digby Jones, and two others to agree on Newsnight that £10bn should be cut from tax expenditure on pensions as a contribution to the deficit. I have since refined this into a detailed policy. If you give me an email address I will send it to you.
Apologies if you’ve covered this already, but should we also look at regulation of the way pension funds charge for the so called services they offer? Many charge a 5% initial commission on contributions and then 1.5% annual commission on the value of the fund. Over 25 years the cumulative effect of this structure is that the total fees paid to the pension company can be up to 25% of the gross contributions made by the policy holder – meaning that the tax relief on contributions goes straight to the bottom line of the financial services industry rather than into the policy for the benefit of the holder – regardless of what return the pension company generates. They get paid regardless of whether they perform or not. All the time fees are linked to fund value (which is growing because people are making additional contributions, not because of investment returns) then the state and the policy holders will come 2nd to the interests of the pension company. Perhaps we should look at ways fees can be linked to performance rather than total fund value.
@Deeply Depressed
Excellent point
Well made
Highly relevant
The capture of the state by the private sector yet again
Is (e) quite right? You are taxed on interest as it accrues in a deposit account, and then subsequently free to withdraw the money without paying additional tax. By contrast, amounts put into a pension fund are tax-free going in, but taxed when they are paid out (many years later). It is therefore deferral rather than an absolute exemption or subsidy, and establishing the net cost of the tax benefit to the Exchequer is therefore not a simple matter of totting up the tax relief (I suspect it is actually rather complicated).
@Marc Daniels
So because putting money in enhances the capital at the outset somehow that’s not saving but is instead income deferral?
Sorry – that’s a nice rhetoric
But that’s all it is
Pensions are savings with tax incentives attached
That’s all
And those incentives don’t work
No, it’s not rhetoric, and your glib dismissal here is telling. Saving through pensions schemes is precisely income deferral, no matter how you spin it.
@Dan Jones
Hang on. Let’s get facts right: economic facts right
When a person saves they do so out of income. They have chosen not to consume now, but to potentially do so later (they may not – that’s one reason for requiring a risk return). All saving is of that nature: let’s not consume now – let’s consume later.
It does not matter whether what medium is used – ISA, pension, deposit account, etc., this is the reality. Current consumption is deferred.
The tax treatment is different. If you save in a deposit account then the capital going in will have been taxed before deposit, the income will be taxed as it accrues but the withdrawal will be tax free. The income and capital are taxed once. With a pension the capital going in is untaxed, the income accrual is untaxed, the combined withdrawal is taxed, once, but later. The delay is the advantage because (but for the charges which as noted above often eliminate the benefit) capital accumulation in a pension should be greater than in an account which is taxed before deposit and with income taxed as it accrues because of the favour this grants when compounding.
But that’s the sum difference. Nothing more or less.
Pensions are just a tax favoured savings mechanism with in the case of final salary schemes a rather odd mechanism for calculating returns – which still does not alter the underlying economics.
That was not my point. You said that pension funds were a tax break. I responded that they are mostly tax deferral.
This is a straightforward point. Funds are relieved from tax on entry into the pension fund, and investments are exempt from tax during the life of the pension (excluding stamp duty). But when funds are finally withdrawn from the pension fund, the 25% lump sum is tax free but the rest is fully taxable in the hands of the pensioner.
Any calculation of the cost to the Exchequer has to take this into account. Does yours?
@Marc Daniels
No is the straight answer
And nor does HMRC’s
But I understate by omission – defe tax by up to 40% at say 3% compound and calculate the cost…
Enormous
@Richard Murphy
Or alternatively the recovery is very small if you want to look the other way
That is not right – you are overstating, not understating, as you present the £300bn as an absolute cost whereas the cost is really £300bn less NPV of tax on pensioners’ future income.
That’s the correct way to do the calculation, involving fairly heroic assumptions as to discount rate, IRR of the funds invested, lifespan etc. It’s the kind of thing some department of Government has likely done but, if not, I doubt very much it’s worth your time (if it’s even possible given the information you have).
The other way to look at it – inaccurate but much simpler – is to ask how much tax is collected at source right now from payments out of private pensions. The figure will be much lower than £30bn but it will not be zero.
The bottom line is that you are slightly over-stating your case, but it is a point of detail and correcting it will make your paper stronger rather than weaker.
nb there is a typo in your post – the cost is £30bn/year over ten years, not £300bn/year.
@Marc Daniels
The one thing you can’t do is offset current pensioner’s tax
That’s apples and oranges stuff
I agree – a small adjustment could be made
But it would be fairly small and does not alter the susbtance of the issue
If the government lets me keep my money, it is not giving me money, it is simply not taking it.
Much in the same way that a burglar does not give me money by not stealing from me.
I read “Making Pensions Work” and assumed it was a spoof. I’ve never seem such illogical, badly thought through and deliberately misleading nonsense in all my born days. It’s actually quite frightening that this is (I gather) presented as a serious piece of reasoned research.
“Sixthly, employee co-ownership of their business through their pension funds will become more commonplace. This is now widely seen as a successful business model.” Priceless! It worked so well for Daily Mirror pension scheme members, it was made illegal! Priceless.
I get tax relief at 20% on my pension contributions and what I get out in retirement is taxed at 20% (including any income and gains that have at the time accrued tax free). Can someone point out the huge tax avoidance opportunity that I am obviously missing out on here?
@DagnehamDave
Wrong
You re only entitled to your net income
You have no title at all to the rest
The law that gives you title to your net income gives title to that due in tax to HMG
@David
I’ve never seen such an illogical comment
I presume it is a spoof
Fraud does not prove invalidity of an idea
It suggests the need for better regulation – that is all
As for your tax comments – tell me why it is better to give tax relief, captured by the City, to ensure your pension costs twice what it should?
Deal with the real issues in other words – please
As I mention on AccountingWeb, all pensions are effectively state funded. After all they are all pretty much backed by gilts and there is very little other reason for index linked gilts to exist.
All gilt interest is just state spending – corporate welfare if you like – and the tax relief on pension payments appears to be just the same.
The state can obviously afford it since it is not financially constrained and so it can invest in other things as well, but is it a good use of public money? Could those whizzkids in the city be doing something more productive?
What’s the reason for encouraging unequal distribution of savings for retirement anyway? What’s the vice we’re trying to deal with?
@mary campbell
Pension Tax relief I can go with, but lets not forget that high earners pay the highest amount of tax in both absolute and percentage terms.
Public funding of education as far as we can is a no-brainer business case. It’s the only public infrastructure project that will last and grow. You get a bigger economy that is more productive. The arguments for people paying extra for being educated are just plain wrong. Education pays for itself in macro terms.
Now that’s not to say we have got the tax system distributionally correct. When you have low paid workers on an effective marginal rate in the 90% range and the top of town paying just 18% if you’re lucky, then there is clearly something very wrong somewhere.
@Dan Jones
All saving is income deferral in that sense.
I’ve no doubt if you do the same analysis with ISAs, or child trust funds you’ll find that the ‘tax relief’ actually turns into corporate welfare for our financial institutions.
And with an economy short of demand, we really don’t need people deferring. We need them spending.
@Neil Wilson
Precisely
“The private pension industry pays out less in pensions each year than the state subsidy it receives;”
What is the point in equating these two figures. The subsidies now are funding pension payments in the future – in up to 40 years time. The payments now are made from contributions made over the last 40 years. Surely the subsidies now are larger becasue more is being saved and more will be paid out in the future.
The fact people are saving for retirement should be encouraged. The state scheme is developing a bigger and bigger liability as people live longer. Those that provide for themselves end up needing much less state assistance in old age. This reduces the demand on funding and enables more state money to go where it is needed.