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Pushing more Defined Benefit (DB) schemes to closure – as many as 250 in the next 9 months
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Resulting in a 2% pay cut for public sector workers, amounting to a £400m pa drop in take home pay for workers in the Local Government Pension Scheme (LGPS)
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Reducing average Defined Contribution (DC) pension pot sizes from £30,000 to £24,000
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Potentially leading to a collapse in retirement savings, putting a heavy burden on future generations of workers
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The costs of administrating a dual tax system (e.g. some pension taxed, some not) could be considerable
Commenting on the Green Paper, Calum Cooper, Partner at Hymans Robertson, said:
“The Government is right to consult on these proposed major changes to the pension tax relief system. Its stated motivation for these proposals is aligned to what we want to see – long-term savings locked in to guarantee more certain financial futures. The guiding principles are to make pension savings simple and transparent, as well as to encourage personal responsibility, building on the success of auto-enrolment.
“This is a hugely complex area, and while flipping the tax relief treatment on pensions may seem attractive on the surface in terms of increasing engagement, the Government needs to proceed with care as there are a range of potential unintended consequences. The Green Paper says the Government will consider providing a top-up to contributions. While this sounds like a good idea in principle, as ever the devil will be in the detail.
“In the Consultation the Government asks how it can make sure that any reform of pensions tax relief is sustainable for the future. The only way this can happen is if we have an Independent Pensions Commission to set and manage pension strategy for the long-term, in same way that the Bank of England sets monetary policy. The need for cohesive long-term planning on pensions could not be greater. Taking the decision making away from successive Governments is the only way this can be achieved.”
Discussing potential unintended consequences of flipping the tax treatment of pensions, he said:
“George Osborne said today that “Britain deserves a pay rise and is getting a pay rise”. If the tax relief on contributions is removed as per the Pensions Green Paper, then public sector workers could actually be faced with a pay cut. Removing tax relief will mean that many will be hit with an unexpected tax bill. This could reduce take home pay in the local government pension scheme in England and Wales by £400m each year. A local government worker on an average salary of around £17,000 will see a reduction in take home £220 pa.
“In the private sector, two thirds don’t save enough already. Would making pensions ‘more like ISAs’ increase engagement sufficiently to offset the reduction in the size of pension pots? There would also need to be some degree of ‘lock in’ as otherwise the money will flow back out again pretty quickly. If this happened it would undermine the time, resource and money spent on auto-enrolment by both the government and employers.
“Ending tax relief on pension contributions could also hasten private sector DB scheme closures, coming at an unhelpful time for DB schemes with ultra-low long term interest rates and the end of contracting out of the State Pension from April 2016. If no action is taken, these changes will push up DB costs considerably, leading to many more scheme closures over the coming 9 months – reaching the half way mark of full scheme closure for UK DB schemes. This this is an additional 250 scheme closures in the next 9 months with hundreds of thousands of people no longer accruing DB benefits.
Commenting on changes to the tax relief annual allowance for high earners, he said:
“Osborne confirmed implementing a sliding scale of annual allowance that tapers from £40,000 at £150,000 of earnings to £10,000 for those who earn more than £210,000. This will boost government finances to the tune of £1.4bn helping to fund increases to the Inheritance Tax Allowance. While we believe the current model of tax relief is distorted, with too much of the value flowing to higher earners, this could create a minefield in the DB space.
“The tapering of annual allowance for higher earners to £10,000 will lead to anyone earning a DB pension of more than £700 pa paying tax on the excess at the point it is earned and then again when it is drawn down. Without careful planning, members run the risk of potentially incurring a round trip tax of up to 65%. This is likely to reduce the levels of engagement from higher earning DB savers and will lead to a quickening of the pace of DB scheme closures.”
Commenting on Hymans Robertson’s view on a fairer way to deliver tax relief, he added:
“We do need a model that’s more equitable for all UK pension savers, but it needs to give everyone an incentive to save. A flat-rate tax relief on pension saving, perhaps at the 33% level suggested by Steve Webb, the former Pensions Minister, would do that.
“The government top up, suggested in the Green Paper, could be structured in such a way to effectively achieve a flat tax relief rate of 33%, by making the top up 50p in the net £ of contribution. This could be an area for the Government to look at.
“Politically these proposals are an extension of freedom and choice. Given so many people in the UK show real difficulty in managing their own finances well, giving them responsibility to plan over several decades to save for retirement could lead to many more poor elderly people in the future which will put more pressure on the state pension as more and more people are left to rely on this or other forms of government benefit to support them in old age. Future generations of workers could be left shouldering a heavy burden. We agree that we need a system that’s sustainable but fair, that rewards people for taking control of their finances, encouraging saving. The only way to ensure we get one is to set up an Independent Pensions Commission.”
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