An ISA-Centric Savings World

In a new report An ISA-Centric Savings World, published by the Centre for Policy Studies on Friday 9 October, Michael Johnson slams the current system of pension tax relief, arguing that it is expensive, incompatible, inequitable, illogical, incomprehensible and, crucially, an ineffective use of Treasury funds.

Welcoming the Chancellor’s call for consultation on the future tax regime for pensions, Johnson proposes that:

  • all Income Tax and NICs relief on pensions contributions be scrapped, to be replaced by a more redistributive 50p Treasury incentive per post-tax £1 saved.  This should be paid irrespective of the savers tax-paying status, thereby nailing the conundrum that because Income Tax is progressive, tax relief is inevitably regressive.  Note that a 50p incentive would significantly help realise the Pension Commission’s vision for median earners to have a two-thirds total combined earnings replacement rate;
  • employer contributions, taxed as employee income but eligible for the Treasury incentive, would be paid into a Workplace ISA, operating within the auto-enrolment arena. Withdrawals would not be permitted until the age of 60, thereby trapping the incentive, along with income and net capital gains.  Thereafter, they would be, ideally, tax-free;
  • auto-enrolled employee contributions, paid post-tax but attracting the Treasury incentive, would go into an employee’s Lifetime ISA;
  • the Workplace ISA and Lifetime ISA could reside within an ISA warehouse, alongside other segregated ISA cells dedicated to specific saving purposes (Help to Buy, long-term care, etc.).  The ISA warehouse could become a universal, all-purpose savings vehicle to serve everyone from cradle to grave. Simplicity to the fore; and
  • each ISA cell would have its own (tax-based) incentives and deterrents, to reflect prevailing policy objectives.  They would share a modest annual allowance, such as £8,000, subject to Treasury modelling confirmation. A smaller incentive, for example, could accommodate a higher annual allowance.

The paper also introduces the idea of an ISA Pension, secured with Workplace ISA assets, from the age of 60.  Given the individual and societal benefits of annuitisation, a Treasury-funded inducement should be considered, such as a 25% income uplift. Indeed, this approach could be extended to today’s ISA suite.  Participation would be optional, consistent with 2014’s pensions’ liberalisation.

Michael Johnson explains:

Drawing on international experience, a “Big Bang” approach is favoured in terms of the transition to a TEE* world.

The primary driver for moving from pensions’ EET framework to the TEE world of ISAs is the inflexibility of pension savings prior to 55. This is at odds with how those in Generation Y, in particular, are living their lives. Many eschew pension saving, thereby missing out on tax relief, but engagement with ISAs is high. Ready access and flexibility is valued above tax relief: EET is patently failing the next generation.

In addition, a single TEE tax framework for savings would represent a marked simplification of the savings arena. But, in progressing from EET to TEE, it would be naïve to assume that the Chancellor would pass up an opportunity to reduce the budget deficit by at least £10 billion per year; nor should he.

Industry opposition to an ISA-centric savings arena is rife. One trade paper recently ran the heading Concern ISA-pension merger would harm savings culture to reflect the angst oozing out of industry CEOs. Sorry, what savings culture? The UK has one of the lowest household savings ratios in the OECD.  This, combined with our apparent addiction to expensive consumer credit, is a dangerous cocktail. We should remember that society is shaped by the significant majority, many of whom EET ignores. Hopefully the national interest will trump narrow vested interests.”

Click here to see the full list of proposals and to read the full report.

Media Impact: 

*     This paper has adopted the pension industry’s form of product codification for tax purposes, namely Exempt or Taxed, shortened to “E” and “T”. A product’s tax status is described chronologically by three letters, either E or T, where the first letter refers to contributions (of capital), the second to investment income and capital gains and the last letter to capital withdrawals or pension income.

Michael Johnson - Saturday, 10th October, 2015