The UK pensions and savings arena must be simplified in order to secure Britain’s long term savings future. We could gravitate to a purely TEE* framework, which would require the accommodation of today’s EET-based defined benefit (DB) schemes. However some within the industry, seeking to preserve the status quo, claim that this is just too difficult. Not so.
In What of DB, in a TEE World?, Michael Johnson offers some suggestions.
Image: Simon Cunningham
The report considers the potential tax treatment of three distinct components of a DB pension scheme operating within a TEE framework.
- Accrued defined benefits as at Demarcation Day (D-Day), the day of cessation of the EET framework. Grandfathering (i.e. ring-fencing as EET) is conceptually simple, but an alternative, a one-off reduction in D-Day accruals, accompanied by a matching charge to DB funds, would take the past EET world into the future world of TEE. It would avoid the operational complexity of two tax frameworks co-existing for decades to come, and would also be more attractive from a Treasury perspective.
- DB deficits as at D-Day. If TEE were to become universal, the Chancellor would come under pressure to retain Income Tax and NICs reliefs on employer contributions in respect of repairing D-Day deficits. Consequently, the annual saving to the Treasury from ending these reliefs would be initially some £10 billion lower than what may otherwise be expected, i.e. some £30 billion, partially offset by Lifetime ISA (and, ideally, Workplace ISA) bonuses. In addition, Income Tax receipts from pensioners (£13 billion last year) would diminish over time.
- Taxing post-D-Day DB accruals as a benefit in kind. The choice of methodology is essentially between simplicity, fairness, and a mid-range compromise. Given that DB schemes are already inherently “unfair” to many individuals, simplicity should trump fairness: employer contributions should be used as a readily-quantifiable proxy for the annual accrual.
Michael Johnson explains:
“The government’s underlying objective should be to create a coherent ISA-based savings framework with a single savings vehicle combining both private and workplace-derived savings, serving from cradle to grave. Simplicity to the fore. The recently announced Lifetime ISA, immersed in the auto-enrolment regime and ideally incorporating a Workplace ISA, could be such a vehicle.
The “What of DB in a TEE world”? question can be resolved without triggering operational paralysis amongst industry providers: it is as much a question of will.
Strong leadership from government may be required, but recall that other nations have successfully transitioned from an EET savings framework, including Australia (to ttE, since 2007) and New Zealand (to TTE). Indeed New Zealand ceased all up-front tax incentives on pensions contributions overnight on 17 December 1987, i.e. without any warning. It can be done.”
Click here to read the full report.
* Retirement savings products are codified chronologically for tax purposes. Pensions are “EET”, i.e. Exempt (contributions attract tax relief), Exempt (income and capital gains are untaxed, bar 10p on dividends), and Taxed (capital withdrawals are taxed at the saver’s marginal rate). Conversely, ISAs are “TEE”, although the forthcoming Lifetime ISA, with its 25% bonus, could be more accurately described as TiEE (“i” for incentive).