Political football with pensions tax relief

Today’s FT Westminster blog states pensions tax relief is once gain going to be kicked around and become a key battleground as part of the election. Labour are proposing to reduce the relief to 20% for those paying 45% tax.

To me the whole concept of removing such relief is crazy. It will mean people are taxed twice on their money, 25% on the way into the pension and at least 15%, but for those in question likely 30%+, on the way out. This results in an overall tax rate of 55%! Of course the result should just be that no pension savings are made but this is an odd message to give. We already have both an annual and lifetime allowance for tax relief. Do we really need any more restrictions?

My tweet response to this was quickly followed up by Greg Kingston (@GregKingston) who summarised the political landscape well with:

@markjrowlinson @JosephineCumbo @ftwestminster always good to campaign on something most people don't understand. Lowest number will win.

It is this kind of politics that leads to division and the desire, from those that can, to look into ever more complicated tax avoidance schemes. I’m all for a progressive taxation system buts let’s keep it simple and be honest about it – that way we are all in it together.

It also reminded me of this little story who I have no idea who to credit to. There are many variants around but they are worth remembering from time to time. In particular the first part shows why it is only reasonable for the those paying more to gain more out of cuts and reliefs and the second why we should always avoid being too envious of those who earn more than us.

Let’s suppose 10 people who work together go to a restaurant after every payday, and at the end of the meal the bill comes to £100. They agree to cover the bill according to how much they earn.

The manager pays £55
The two supervisors pay £11 each
The four file staff pay £5 each
And the three junior staff pay £1 each

———————–

The regular meals continue for a few months and eventually they manage to convince the restaurant’s owner that, as they’ve been frequent and loyal customers and the restaurant is doing very well, he could give them a 20% discount. This leaves them with a £20 windfall to divide between them.

The first idea the restaurant owner proposed was to split the savings evenly between them, so each gets £2 – leading to:

The manager paying £53
The two supervisors pay £9 each
The four file staff pay £3 each
And the three junior staff receive £1 on top of their (now) free meal

Obviously the 7 paying colleagues weren’t very happy with this arrangement – so the restaurant owner said “Fair enough, we’ll divide the windfall among you, proportional to how much you contributed to the original bill.”, leading to:

The manager paying £44
The two supervisors pay £8.80 each
The four file staff pay £4 each
And the three trainees pay 80p each

The trainees then complain that their share of the £20 windfall is 20p while the manager’s is £11 – how is this fair?!

———————–

Let’s see what happens if the situation was to be reversed: the restaurant hits on hard times and raises the prices by 20%, but nobody wants to simply order less food. The manager proposes everyone contributes an extra £2 each so:

The manager pays £57
The two supervisors pay £13 each
The four file staff pay £7 each
And the three junior staff pay £3 each

The junior staff are not happy at all – the cost of their meal has tripled! So, they suggest everyone just contributes 20% more than what they used to for the original bill:

The manager pays £66
The two supervisors pay £13.20 each
The four file staff pay £6 each
And the three junior staff pay £1.20 each

To which the manager says “Sorry, I’m not going to pay £66 for a meal – I’m already paying for much more than I get. In fact, if you’re going to insist, I’ll find some less demanding friends and go to a different restaurant with them.” – leaving the remaining colleagues to cover the (now £108) bill between the 9 of them.

The moral of the story?
Don’t go to restaurants you can’t afford… And if you do, don’t get greedy with other people’s money!

Reduction in the annual allowance – an opportunity

I read Josephine Cumbo ‘s article on pension tax relief being back on the agenda for Osbourne’s Autumn Statement in Sunday’s Financial Times with interest. The suggestion was that the annual allowance, the maximum amount you can put into a pension and claim tax relief on, may be reducing to as low as £30,000 a year.

I actually see this as an opportunity. I blogged just recently on my view on how long term savings can be improved and a reduction in the annual allowance for pensions makes such a scheme even easier to implement. Combine this fall in the pension annual allowance with an increase in the ISA allowance to same amount and you are well on the way to getting rid of pensions policies in place of flexible savings vehicles with incentives to keep money invested for retirement.

Industry interests

Someone commented earlier on a copy of my blog on Mallow Street that ISAs:

do not generate commission, and from the pensions industry point of view, this is a disadvantage. Indeed, they would compete for funds with conventional dc pensions.

Competing with conventional DC pensions is precisely the idea! This comment comes after comments from Michael Johnson that providers are holding back pensions reform. The pensions industry needs to stop worrying about change and have a good hard look at itself. It only has its self to blame for any industry wind-up.

Rethinking pensions saving

Anyone who knows me in pensions knows that I don’t like Defined Contribution (DC) pensions. They also know that I do like Defined Benefit (DB) pensions, that I believe these to be the most efficient way of providing pension benefits and that I am convinced that better regulation and scheme design is all that is needed for these to thrive again. However, it is hard not to accept that the change in direction that would be needed for this to happen is huge. So in the meantime we need to make DC better.

We need something new

DC pensions are actually nothing new. In fact I would go as far as saying they are very old, as old as DB pensions. What’s changed is that long ago when DB thrived DC was targeted at high net worth people who wanted control of their investments. Now DC is being targeted at the masses who don’t. What they want is either pension or savings. My biggest criticism of DC pension schemes is that they are not pension schemes, they are tax advantaged savings with strings attached.

Today’s world is very different and the young people of today have different problems. Is it right that we (as a nation) are trying so hard to encourage them to put money into a pension policy that they can’t access for 30, 40, maybe even 50 years. I certainly don’t want to and dislike the tax incentives that mean I sometimes feel I have to.

A new form of savings account

If we started with a blank sheet of paper what would we like to achieve?

I think we would look to achieve the following:
– Something that encourages people to save.
– Something that allows people to use money how they want.
– Something that encourages people to make long term savings such as for retirement

How can we achieve this?
– Tax relief on savings made (in line with relief currently on pension savings)
– Complete flexibility to take the money when you want (like an ISA)
– Pay back of tax relief on withdrawals made before retirement (to provide a disincentive to early withdrawal)

The current tax positions and flexibilities of both pensions savings and ISAs would be replicated but people wouldn’t have to make the choice of pension or ISA. Savings would be there to be used when needed.

This would be revenue neutral to the extent that we are happy with the current tax relief position of pensions and really mean it when we say we want to encourage more savings.

It would also come with the advantage of being able to abolish DC pensions with a rebranded ISA, a name that people trust.

Let’s really have a savings revolution.