Alastair Meeks,Â former chair of the Association of Pension Lawyers, looks at George Osborne’s plans for pensions.
When I qualified as a pension lawyer, my first boss used to say: “Alastair, when people hear the word ‘pension’, they think ‘old’, they think ‘grey’, they think ‘boring’.Â But if every time you hear the word ‘pension’ you replace it with the word ‘money’, suddenly it seems so much more exciting.”Â Today I’m going to talk to you about money.
We have now had five years of austerity and the deficit stubbornly refuses to close completely.Â One of the most successful cost-savings measures was taken very early on, when the government changed the basis of inflation from RPI to CPI for public sector pension and most state benefits.Â This saved billions – roughly Â£4.3 billion in 2015/16 alone and rising every year (a cumulative value of the order of Â£100 billion).Â Not bad for a technical change that no one really understands.Â The government may have found another similar technical change for pensions that no one really understands.
In the 2014 budget, George Osborne made a dramatic announcement relaxing the restrictions on taking pension money.Â Since then, we have had a succession of announcements at budgets and Autumn Statements that indicate we are in the middle of a longterm plan to remodel the foundations of pension scheme taxation.Â The reaction of most people when they read the words “remodel the foundations of pension scheme taxation” is to run away whimpering.Â But never leave a Chancellor of the Exchequer with a deficit to plug alone with your money.Â He may be about to commit grand larceny.
In 2014, the Chancellor announced that from 2015 pension pots could be cashed in in full, recognising the unpopularity of annuities.Â This announcement was hugely popular with many of those coming up to retirement.Â It was just as popular inside Number 11, because members who cash in their pension pots over and above the previous permitted maximum level pay tax at a high marginal rate, bringing in money into the exchequer and at a higher rate than would otherwise have been paid on the money coming out.Â It constitutes an optional yet popular tax – perhaps the first since the National Lottery was launched.
But this was not just a money-raising venture.Â A white paper accompanied the budget to explore how a balance could be struck between giving savers full access to their pension and making sure that they were fully informed about the implications of doing so.
(Financial education is the weak link in the whole reform.Â Not enough people have the necessary knowledge to make informed decisions about their options and not enough pension pots are yet large enough to justify requiring everyone to pay for tailored advice.Â The government has required generic guidance to be made available.Â It remains to be seen whether that will be good enough.)
With a government declaration of intent that savers should be given better access to their own money, it was always likely that we would see a return to this.Â Sure enough, the post-election budget trailed the possibility of a much more major change to pension taxation, bringing it into line with the tax regime for ISAs.Â We are due to hear more about that in the next budget.Â Hold onto your wallet.
It should be pointed out that aligning pensions and ISA tax regimes makes quite a lot of sense in the abstract.Â Most people think about saving as a single activity.Â Why should different forms of saving be taxed differently?Â The difficulty comes in the detail.
At present, pension contributions are tax deductible, investment income and capital gains are also tax deductible, while pensions are taxed in payment – though a set level of lump sum is tax free (Nigel Lawson called this much-loved but anomalous).Â In the new world where savers can take all their pension savings in one go, the tax regime strongly influences how in practice savers access their savings.
So, the government has floated the idea that in future we should get our payments from pension schemes tax free.Â To make that work, contributions would be made from net pay, not gross pay.Â Investment income and capital gains would remain tax exempt.Â Savers could then get their hands on their own loot in whatever way they chose without having to worry about falling into taxation pitfalls.
Let’s leave to one side the administrative complexities of the transition (immense, if you must ask) or the problems that such a change would potentially cause defined benefit pension schemes (also immense).Â Those are problems for pension geeks like me.Â Instead, I’ll look at the implications for HMG.
If pension contributions are paid from net pay, tax receipts in the near future would be markedly higher in the short term than they otherwise would have been.Â That’s handy for a government seeking to close a deficit.
Next, because contributions are paid from net pay, those who benefited from higher rate tax relief on their pension contributions would be disproportionately affected up front.Â The government would have found a way to sting higher end top rate taxpayers right now.
Next, because pensions are paid in retirement at a time when most people’s income is lower than when they were in employment, the value of the tax foregone at the payment stage is considerably lower than the value of the tax currently being foregone at the contribution stage.Â If, for example, you’re a higher rate taxpayer now and you expect to be a basic rate taxpayer in retirement, you won’t just lose out because you pay tax sooner, you’ll lose out because your marginal rate will be higher.
Finally, the government would have abolished the additional cost of the tax free lump sum without anyone even noticing, because the cost would be taxed at the contribution stage, not foregone at the payment stage.
I have no doubt that the Treasury has a clear idea of the improvement in the tax position that its floated reform would bring in.Â I have no doubt that it is a very large number indeed.Â The net cost of tax relief in 2011/12 is estimated by the Treasury at Â£38.3 billion, though others including the IFS have queried this figure.Â The cost to the Exchequer of the tax free lump sum by itself has been estimated at Â£2.5 billion a year.Â Even with the benefits coming in over time by transition, the numbers could be eye-popping.
Pensions professionals are generally quaking at the possibility of the change (admittedly for reasons of personal workload and aesthetics as much as anything else).Â My expectation is that the government will push it through, simply because of the size of the tax gains to be made.Â The fall-out is likely to be relatively minor.Â Can you work out how much money you would stand to lose personally?Â Nor could just about anyone else.Â With a few well-chosen sweeteners, most people would be too uninformed to realise that they’d been robbed blind.
So watch out for this heist on 16 March.Â It promises to be a record-breaker.
Alastair Meeks is Pensions Partner at Pinsent Masons and has writtenÂ books on the topic of pensions law.