HM Treasury: restriction of Pensions Tax Relief, a discussion document on the alternative approach

Comments from ACCA to HM Treasury, August 2010.

Executive summary 

ACCA welcomes the openness of the Government to explore a new approach to the restriction of tax relief on pension contributions. We agree that the implementation of any new restrictions of tax relief must reflect the virtues of fairness and simplicity.

ACCA remains concerned however that the occupational pensions industry (or at any rate the defined benefit (DB) sector) might be unable to withstand another very substantial tax raid.

While the arrangements originally put forward were complex and burdensome, those now being proposed risk extending restrictions on tax relief to a wider group of individuals and are likely to have consequences which many will see as unfair.

By spreading the net of those caught by tax restrictions, some of the very highest earners are likely to pay less tax (i.e. will benefit from more relief) under the new proposals. Given the current impact of the austerity measures on the less well-off, we query whether this would satisfy the test of fairness. The Government needs to address this issue and adopt measures which will curtail the impact of the new restrictions further down the income scale or risk being accused of failing to encourage saving in the spirit of the self-helping 'Big Society'.

The proposals are likely to impact disproportionately on those members of DB schemes who have long service records, meaning that those approaching retirement, and perhaps already planning for their retirement, will be especially affected. For such individuals, even a small increase in their pay, even a cost of living adjustment, risks exposing them to the new tax charge, and the higher the flat factor that is adopted, the higher that charge will be. The proposed arrangements risk also having a significant, and unfair, impact on deferred members. We recommend, therefore, that the proposed arrangements be amended so as to recognise the need to treat the tax position of individuals in these groups with more sensitivity.

Our wider concern is that if the new restrictions have the effect of discouraging pension saving among individuals on significantly less than 'high' earnings, they could accelerate the decline of the sector, especially DB schemes. This is at a time when the Government's policy remains to encourage and even mandate supplementary pension saving. The previous government was exposed by its actions to charges of taking a short term approach to long term investments such as pensions. ACCA hopes that the new government will not lay itself open to similar criticism.

The new arrangements need also to be put into effect in a way which is administratively feasible and which minimises the compliance burden for both employers and scheme members. In this regard it should be acknowledged that the proposals will impact upon many individuals who do not routinely account for their tax liabilities via the self-assessment system and who thus cannot as it stands be expected to account for any new tax charge via this method. We suggest that the Government should consider re-introducing the short -form tax return for all higher rate tax payers, at least for the first year or two of the new regime.

The risk of further alienating employers in the private sector needs also to be considered in the light of the position of public sector schemes, and the current inquiry into their funding. As a matter of social and economic policy we are concerned to avoid exacerbating the distinction between the pension position of workers in the public and private sectors.

Against this background, the impact of the current proposals on the shape of pension saving at all income levels and across all sectors needs to be considered, not just on DB schemes or higher earners. We make a number of proposals to soften the impact of the measures proposed on those most disproportionately affected, including age related AA and the ability to spread either the AA or contributions. We would also support the aligning of PIPs with the fiscal year, rather than individual employers.

General comments

ACCA recognises that the state of the public finances means that all fiscal measures need to be considered in order to reduce the national budget deficit. While we believe strongly as a matter of principle that the rules relating to pension saving need to be organised on a long-term basis, and should experience the minimum of annual change so as to give the necessary confidence to savers, we accept that some attention to the position of tax relief on contributions is probably inevitable.

The proposals need to be considered in the far broader context of lifetime economic planning generally, and not just for high earners but the population generally. Pensions are being reformed in many ways, with the 2012 reforms still scheduled to come in, while at the same time the world of work and employment patterns are changing beyond all recognition. As the workforce becomes more mobile, occupational pension schemes generally are beginning to appear archaic; defined benefit schemes doubly so. The knock-on impacts of these proposed reforms to the pensions landscape generally need to be considered for both existing savers, some of whom will have made their choices and been contributing to their schemes since before the current prime minister was born, and for future savers.

The sticking point will of course be the unfunded public sector schemes. Currently, public sector employees are often said to earn less in current salary on the basis of a promise of higher pension on retirement. In theory, the public sector should be able to do the same as the private sector and move to a situation where higher current salaries are paid but attracting lower pension benefits. In practice this will be unaffordable, as the cash that would be needed to pay the higher salaries cannot be supplied by reducing funding contributions for the current employees as no such contributions have been budgeted for. Instead, the money is being applied to pay existing pensioners and cannot therefore be diverted to also pay current employees. Unless or until government is prepared to tackle this, the division between public and private sector remuneration patterns will persist and increase.

We set out below our responses to some of the questions posed in the consultation document.

Specific questions 

1 There are currently exemptions from the AA test which would undermine the ability of a reduced AA to restrict pensions tax relief effectively. In implementing a reduced AA, the Government would remove the exemptions from the AA test in the year benefits come into payment, and the exemption for individuals claiming enhanced protection under the Finance Act 2004 tax regime. The Government welcomes views on any other changes that might be necessary to ensure the AA operates effectively and to address the risk of avoidance that could lead to further significant and potentially adverse changes to the regulatory regime (Paragraph 2.7);

ACCA is concerned at the scope of changes to the AA provisions which are being proposed just five years after the upheaval of A-Day. A simpler and more equitable solution might be to exempt all previously accrued benefits from the new regime, which would do away with the need to revisit the enhanced protection provisions. Combined with a specific exclusion for all deferred members this would simplify the new regime and reduce the administrative impact of the changes on the pensions industry.

2 By only taking the newly accrued amount of annual pension in a DB pension into account, the use of a flat factor potentially creates opportunities for DB pensions to be used to grant additional pension value without this counting towards the AA test. The Government therefore welcomes views on this issue and practical options for limiting it, including the option of requiring a CETV calculation, or the use of age-related factors, in specific circumstances to capture the value of certain pension enhancements (Paragraph 2.11);

The identified risk of additional value being transferred into pension schemes could be offset by introducing CETV calculations or ARFs. A simpler alternative which would work for both DB and DC schemes, and address what we see as the structural unfairness of the current proposals, would be to offer age related AAs. Say 20-30 £25k, 30-40 £45k, 40-50 £55k and 50+ £65k. Those in a position to put larger sums into their pension pots earlier in life are most likely to have the capacity to save for their retirement in other ways. For the majority of DC savers, the current AA will be unattainable for the majority of their working lives either because in early years they are not earning enough, or, towards the middle of a career because costs of raising family etc will preclude significant saving. This means that towards the end of their career, savers will want to try to play catch-up; the current proposals prevent this.

3 The Government would welcome views on the treatment of deferred members, revaluation and negative accruals, with a flat-factor approach to valuing DB accruals, and evidence on the administrative burdens of the different options (Paragraph 2.16);

The proposed escalation in flat factor rates from 10 to 20 while reducing the AA 5 fold effectively cuts tax efficient saving by a factor of 10 for the very highest earners. The basis for a flat factor greater than 10 is clear from even the most cursory investigation of annuity rates. However, even at their current 20 year low, most annuities are paying returns of around 15 to 1, suggesting that adopting a flat factor of 20 would distort the impact on DB members, specially if past accruals are included, relative to DC members. ACCA would favour a more gradual increase in the flat factor, and the ability to revise flat factors on a bi-annual basis to reflect movements in the annuity market.

Taxing deferred members on the movements in the value of their pensions seems to us unfair. The (ex)employer is not directly giving them a benefit, and there is an increasing likelihood, with the increasingly bleak outlook for many DB schemes, that the pensioner will never actually see the benefit of the accruals. (Obviously here we are only talking about private sector funded schemes.) Imposing the restrictions on deferred employees would also be very complicated, and massively increase the administrative burden both on schemes and HMRC. Changes in the level of deferred benefits are going to be low.

4 With an AA operating at a significantly lower level it is important to consider whether exemptions from the limit should be granted in particular circumstances, while managing risks of avoidance, including the cases of death, serious ill health, redundancy, ill health, transfers and divorce. The Government would welcome views from interested parties on these issues and any other specific circumstances under which there may be an argument for applying the AA in a particular way (Paragraph 2.17);

Cutting the AA to such a low level would cause problems for those with "lumpy" income streams - eg farmers and the self employed. If the Government is serious about encouraging pension saving by these groups then some type of averaging should be introduced to enable them to carry back contributions into years of low income or carry forward unused AA into years of high income. Absent such an option, the LTA will become little more than a tantalising dream for many savers - as it is, an AA of £30k would make an LTA of any more than £1.5m an absurdity, needing 50 years non-stop contributions at the absolute maximum limit to achieve the required fund; it is hard to conceive of any situation where this might happen in reality.

5 Individuals may receive from their employer a significant increase in the value of their pension in cases of ill-health early retirement or redundancy. It is not clear that it would be appropriate to apply an exemption from the AA in these cases. Given the risks of avoidance, the Government is minded not to provide exemptions from the AA in these cases, but is willing to consider proposals from interest groups that would provide protection for individuals in particularly hard cases without opening up unacceptable scope for abuse (Paragraph 2.19);

The route taken to discourage abuse of any ill health provisions should not be to make them so onerous or expensive to comply with that only genuine cases even attempt to bother. A simple discretionary review by HMRC, but with the corollary that HMRC will charge at full professional rates for the time taken to review if the application is unsuccessful, might be a good starting point. Genuine and deserving claimants would face no significant burden or costs; chancers would be discouraged by the possible cost implications. It would be entirely appropriate for any such review to be implemented on a case by case basis, as illness relief will always be on an individual case basis. Hence there is no scope for an automatic design feature to trigger the relief/review. For redundancy cases, again the review should be on a case by case basis - although there may be scope for HMRC to save costs where a number of individuals are made redundant as part of the same process, employers should be put on notice that the costs will be charged as though each were a stand alone review; redundancy cases are more open to abuse, so should be open to a higher level of deterrent.

6 The Government welcomes views on the appropriate level of the LTA, other issues associated with its operation in the context of a reduced AA, and on the trade-off between these and the level of the AA (Paragraph 2.25);

The current level of the LTA is too low relative to AA (or conversely the AA too high relative to LTA) as a high earning individual can exceed the LTA limit within just 8 years. However, the proposal for eg a LTA of £1.5m with AA set at £45k would mean 40 years of non-stop top level contributions to reach LTA ,which is probably too far in the opposite direction; for future generations, the LTA would become an irrelevance. However, reducing it further below £1.5m would be unfair on those currently between £1.5m and £1.8m who have deliberately saved to that level. Moreover, given the decrease in annuity values available driven by the increased longevity of pensioners, a reduced LTA will increasingly render pension saving an irrelevance unless the government commits to future increase at the very least in line with the cost of living.

7 The Government would welcome views on the merits of capping relief at 40 per cent as an additional means of restricting pensions tax relief and the trade-off between this and the level of the AA (Paragraph 2.27);

In general, the higher the AA the better, as this will reduce the number of people caught. However, setting the relief at 40% flat instead of marginal rate would reintroduce much of the complexity that made the previous suggestions so objectionable.

8 The Government is keen to support employers to make adjustments to help individuals who may face large, but one-off, increases to their DB pension. The Government welcomes views on legislative action that could facilitate appropriate scheme redesign without undermining other aspects of the regulatory regime (Paragraph 3.10);

Implementation of averaging as discussed above could be used to offset spikes, with age related AAs serving to reduce the impact still further.

9 The Government welcomes views and evidence on the benefits and burdens associated with aligning the pension input period to the tax year, for individuals, pension schemes and advisors (Paragraph 4.12);

In an environment where 'jobs for life' were the norm, aligning the PIP of occupational schemes with the sponsoring employer reduced the overall administrative burden. However, if the system was being built from scratch to service the current market of mobile employees who move from one scheme to another, no-one would suggest the deliberate implementation of non-coterminous year ends for different schemes. 

Standardisation of the year end would have effects far beyond simply the reporting of contributions levels for AA purposes. Looking for a moment to the opposite end of the pensions savings scale, the new generation of savers created by auto-enrolment will include a significant proportion of highly mobile workers. Coordination of fund years would ease the administrative burden in the short run, and in the long term make it possible for providers to consider shared administrative facilities. Industry wide schemes would be easier to operate, and these are expected by the pensions providers to be a growth area once auto-enrolment is fully implemented. Although there will of course be a short term cost in changing systems and the ongoing effect on reporting for sponsoring employers, the long term benefits appear to far outweigh the costs.

10 Given the need to support individuals, the Government welcomes views on the appropriate reporting requirements on pension schemes to provide statements of the total pension input amount over the pension input period (Paragraph 4.20);

In addition to the provision of basic reports to scheme members of their accrued benefits/contributions in a period. ACCA would support the reintroduction of the short form tax return for all higher rate tax payers, at least for the first year or two of the new pensions regime. Receipt of the notice would remind taxpayers of their responsibilities and, for those not currently saving properly for their retirement, remind them of the tax benefits they are foregoing by choosing to invest post tax income in long term assets.

11 The Government welcomes views and evidence on the benefits and burdens associated with introducing reporting requirements on schemes to provide this information (Paragraph 4.20);

The primary burden of such reporting would fall on DB schemes, as most of the relevant information is already provided to DC scheme members on an annual basis anyway. Operating a simplified structure for valuing annual accruals under DB schemes will be key, and removing prior years accruals from the charge to tax would significantly reduce the impact in early years while providers get to grips with the new processes required.

12 The Government welcomes views on how quickly schemes could provide this information before the Self Assessment tax return is due, and whether employers could help pension schemes provide this information in a timely way (Paragraph 4.20); and

Information should be provided to employees by 1 July. This would enable those with tax to pay to arrange their reporting and affairs accordingly, while allowing those who break the AA only as a result of AVCs or other voluntary contributions to revise their contribution profile in order to avoid the new tax charge.