The report, authored by Centre for Policy Studies research fellow Michael Johnson, says today’s tax-based incentives for pension savings are too expensive, costing the Treasury over £54bn in 2012-13, and poorly targeted, with the top 1 per cent receiving 30 per cent of all tax relief.
Johnson says income tax relief should be abolished and replaced with a 50p incentive for every £1 saved. Contributions of up to £8,000 a year would attract the matched contributions under the plan.
He argues that the £270bn of tax relief paid by HMRC since 2002 makes the Treasury the fund management industry’s largest client. Johnson calculates that after 10 years the cumulative costs levied by the financial services industry have exceeded the initial tax relief from the Treasury.
After 17 years, the cumulative AMC received by the industry exceeds the initial
tax relief from the Treasury, and after 29 years, the cumulative AMC received by the industry in respect of the initial tax relief exceeds the tax relief, he says.
The paper also calls for a single unified Isa and pension regime.
Johnson’s calculations assume a single contribution of £100 net, paid into a higher rate taxpayer’s personal pension pot, that is grossed up to £166.67p by 40 per cent tax relief. The money is invested in an actively managed UK equity fund, with annual costs totaling around 3 per cent for a retail investor, comprising a TER of 1.6 per cent (with a 1.5 per cent AMC) and annual transaction costs of 1.4 per cent, assuming portfolio turnover of 58 per cent. The calculations also assume a net return of 2.9 per cent a year – the average for pension funds between 2001 and 2011.
Johnson has been a key influencer of Government policy in the past. Before the 2010 general election he ran a policy group for David Cameron, and his 2010 Simplification is the Key paper is widely seen as instrumental in shaping Treasury thinking on the reduction of the lifetime and annual allowances.
Johnson says: “Excessive costs, including high levels of remuneration – particularly within fund management, and overly-long chains of agents, only fuel public opprobrium. Little, however, has been said about what actually happens to the Treasury’s vast retirement saving subsidy. Where does it actually go to?
“It is interesting that Steve Webb has come out talking about a flat rate 30 per cent tax relief for all. I sent him this paper three weeks ago. I think he has realised there is an opportunity for a land grab here. This is an awkward subject for the Conservatives. But it is an attractive subject for Labour. This could be the glue for a pre-election coalition deal with Labour.”
Hargreaves Lansdown head of pension policy Tom McPhail says: “The CPS proposals look perhaps overly intricate. We don’t think this is a good moment to start attacking the tax free lump sum entitlement. Similarly the proposal for a combined ISA/Pension allowance of £30,000 looks quite restrictive, compared to today’s twin allowances amounting to £55,000. By contrast, the pensions minister’s recent musings around the idea of a flat rate of 30% relief, combined with the scrapping of the lifetime allowance (LTA) look simpler and more attractive.
”The LTA is a policy which is reaching breaking point, both in terms of the increasingly complex protections being introduced every time the LTA decreases and in terms of its negative effect of acting as a disincentive to save and to invest well. Hargreaves Lansdown would like to see a fairly balanced set of incentives which encourage the whole population to build up a good retirement income. Any changes need to be demonstrably more effective than the present set of reliefs. More work needs to be done to examine the behavioural impact of any changes, in order to ascertain what effect they would have on people’s propensity to save. This is something we will be exploring further in the months to come.”
Johnson’s eight proposals
– Pension contributions from employers should be treated as part of employees’ gross income, and taxed as such.
– Tax relief on pension contributions should be replaced by a Treasury contribution of 50p per £1 saved, up to an annual allowance, paid irrespective of the saver’s taxpaying status.
– ISA and pension products should share an annual combined contribution limit of £30,000, available for saving within ISA or pension products (or any combination thereof). This would replace the current ISA and pensions tax- advantaged allowances.
– The 25 per cent tax-free lump sum should be scrapped, with accrued rights to it protected.
– The Lifetime Allowance should be scrapped. It adds considerably complexity to the pensions landscape, and with a £30,000 combined contributions limit for pensions and ISAs, it would become less relevant over time.
– The 10p tax rebate on pension assets’ dividend income should be reinstated.
– People should be able to bequeath unused pension pot assets to third parties free of Inheritance Tax (perhaps limited to £100,000), provided that the assets remained within a pensions framework.
– The annual allowance should be set at £8,000, with prior years’ unutilised allowances being permitted to be rolled up, perhaps over as much as ten years, all subject to modelling confirmation.