By Calum Cooper, Head of Pensions Policy Innovation, Hymans Robertson
The tax relief provided over time would remain the same, and the level of expected net income received by pension scheme members could stay the same when they retire. Through this, the government would gain billions of pounds from tax on pensions contributions right now, but individuals won’t lose out as they would not be paying tax on their pensions later in life. It would not impact company profits either. £20+ billion a year would be brought forward that the Government can invest, for example in the National Wealth Fund (NWF) and Net Zero-aligned sectors, and UK communities and growth.
Outlining how the tax of pensions currently works, Calum Cooper, Head of Pensions Policy Innovation, Hymans Robertson, says: “Under the current pensions tax relief system, the Government provides tax relief on pension contributions as an incentive to save in pensions. For every pound a typical worker, paying basic rate tax, saves, 20p is tax relief. Put another way, when a typical worker gives up £800 of take-home pay to save into a pension, the Government effectively tops it up by £200. This tax relief is an incentive for the worker to save.
This pension money, including the £200 incentive, is then, often, invested overseas. When workers retire, the majority of the tax relief is expected to be clawed back by the Government as most workplace pension income is taxed in payment. In fact, the typical worker who paid £800 into their pension will return £150 of their £200 ‘incentive’ to the Government through tax*. This leaves them with only £50 of extra money in their final pension pot.”
Explaining how pensions taxation could be changed to provide the Government with billions of pounds, Calum continues: “Instead of offering tax relief on pension contributions and providing this £200 incentive - and then clawing £150 back in retirement - the Government could simply give the net £50 incentive-‘Government Bonus’ - that the worker retains as an up-front top-up payment (through tax relief or another mechanism). After this pension savings could be completely tax-free.
“This can be designed so that the expected pensions cash and income received is unchanged**. The £150 of upfront tax adds up to more than £20bn p.a. of extra income to the Government now, rather than decades in the future. Provided this is invested in the UK, and for green growth there is alignment with the interests of future generations too.
This could materially accelerate much needed investment in the UK and could keep expected pension income at retirement and take-home pay unchanged without costing anything more for employers. Because future pensions would be tax free, it would make it simpler and more certain for people to plan for later life.”
Commenting on what could be done with billions of pounds unlocked from pensions by the Government, Calum says: “Overall, this approach brings forward more than £20 billion a year for the Government to invest in UK Growth, whether that is through the National Wealth Fund (NWF), UK communities, and in Net Zero-aligned sectors. If three times as much private sector capital is crowded in to the NWF as outlined in the Chancellor of the Exchequer’s current plans, this would lead to £80bn NWF investment a year.
After a decade it could provide a NWF of more than £1 trillion***. This would positively impact the Government’s debt-to-GDP position over the critical tax5-year time horizon, reflecting that a material state asset is being built up that was otherwise invested globally.
“The scale of this long-term ambition is enormous but achievable***. To do this the communication and oversight would need a great deal of care. But we do not have decades to find the money to meet the UK’s investment and productivity needs, including the commitment to Net Zero. The dividend to the next generation from sustainably investing in the UK, done well, would be huge. This scale of change would need time to get operationally ready, and independent oversight and governance would be essential to ensure that value accretes fairly to the next generation. But all of this gives the NWF time to get to scale too.”
* For simplicity this does not include growth or relief on investment returns (which does not affect the impact or rationale). It reflects the expectation that 25% of pension can be taken tax-free for most people. The remaining 75% is taxed at marginal rates on pension in payment, assumed to be the basic rate here. The same outcomes can be achieved for higher rate taxpayers in employment and/or retirement. However, other design considerations will become important for higher rate taxpayers, like whether to continue to incentivise them by more than lower-rate taxpayers to save into pension: this is a political question. Here we assume a design that sustains current incentives and so pension outcomes for each individual.
** For higher rate taxpayers in employment, if the goal is to expect to be tax- and pensions-outcomes neutral through time, the top up would need to be higher, reflecting the current tax system design. Clearly, in addition, it could also be designed to redistribute incentives to the lower paid e.g. via flat-rate relief. However, here we have focused only on stimulating UK investment to achieve growth and Net Zero.
*** As an extension of this idea, the Government could go further and underwrite and direct how circa £500bn of pensions savings, that is effectively deferred tax receipts, is invested. That is, c£500bn of the current £2.5trn of pensions wealth is expected to be paid to Government via tax on pensions in payment. It could be deemed reasonable that the Government has a say on how this money, that is due to them in time, is invested. However, this is an even bolder and more politically ambitious suggestion, and we suspect it is further than is needed or desirable.
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