This will deliver the Government’s policy objectives with less cost and complexity than moving to a flat rate, says Hymans Robertson

Hymans Robertson, the leading independent pensions and benefits consultancy, welcomes the news that the Government is planning to retain the existing Exempt Exempt Taxed (EET) structure for pension taxation, as the transitional implications of a shift to Taxed Exempt Exempt (TEE) system would have been horrendous, costing employers and the pensions industry billions of pounds. It would have also required a transition of trillions of assets which would have been complex, costly and result in a confusing two tier system with potentially different treatment of DB and DC pensions.

Added to that, Hymans Robertson’s research (a combination of focus group research and a survey of 2000 people¹) showed it would not have strengthened the incentive to save. The firm also surveyed blue chip employers and 93% favoured retaining an EET system².

However, rather than implementing a flat rate of relief, Hymans Robertson recommends modifying the current system by introducing a cap on the rate of income tax relief as this would achieve the Government’s policy objectives with less cost and complexity than a move to a flat rate.

Commenting on the benefits of a capped rate of relief within an EET system, Chris Noon, Partner at Hymans Robertson, said:

Of all the options on the table for Government, modifying the current system to bring in a capped rate of tax relief will represent the smallest change for the greatest policy benefit. It would enable the removal or at least a simplification of the complex system of annual and lifetime limits. It will also target pension tax relief at low and middle earners who are currently under saving for retirement. This will be by far the easiest system to implement, as it will dovetail with existing EET savings, leading to lower cost and complexity of change. It will work equally well for public and private sectors and across defined benefits and defined contributions. It has the added benefit of avoiding undermining the Government’s pledge of not changing public sector pensions for the next 25 years.

For employers and for consumers, simplicity is key. Cost and confusion ultimately lead to disengagement from saving – both at an individual level and from the point of view of employers facilitating saving through the workplace. Clearly any system has to be sustainable, both now and in the future. A capped rate of relief gives the Government an additional fiscal control, introducing a controllable cap on pension tax relief which can be changed independently of income tax bands to help balance the books. It also provides stable long-term costs as a percentage of GDP. TEE, on the other hand, leads to unstable and rising long-term costs which will ultimately be higher than any equivalent EET regime.

Discussing the differences between a flat and capped rate, he added:

Capping income tax relief would be the easiest policy change to implement. Much of the required infrastructure is already in place and the concept can be easily communicated. Fixed rate (or flat rate) pension tax relief would more actively redistribute pension tax relief away from higher earners to low and middle earners, but we are unconvinced that the benefit outweighs the practical challenges. Although the message to consumers from a flat rate system can be simpler, there will be particular difficulties implementing systems for high and low earners. For example, how will the Government be sure that any top-up to low earners implemented through income taxation will be allocated to pension savings, rather than simply boosting current income?

A flat rate system has the potential to be too redistributive resulting in higher and additional rate tax payers not saving into a pension. These are not ‘fat cats’, these are the squeezed middle in terms of pension saving, as well as being those who have influence over workplace pension provision. For example, tax-relief on pension contributions is capped at 33%. Basic rate tax payers would get the full 20% relief but higher and additional rate tax payers would only get 33%.

Discussing the flaws of a move to TEE, Chris Noon, Partner at Hymans Robertson, said:

A move to TEE would have added significant complexity and cost for no perceivable long-term gain. It would have cost around £2.5-£3bn to industry. This would have been borne not just by pension providers, but also by businesses who would have to overhaul their systems, potentially making it more difficult for employers to provide pensions. Given the vital role the workplace plays in pension saving, this would have been a blow to long-term saving. Aside from rising costs in the future and the burden it would have placed on future generations, our research shows that consumer saving is not incentivised by the pension tax regime itself. Instead, change and complexity undermine both consumers’ willingness to save and employers’ willingness to provide savings vehicles. 

A TEE regime would have also been monumentally difficult to implement. It would have resulted in either the complexity of a two tier system for past and future pension saving, or a transitional ‘tax raid’ on past pensions. It’s difficult to see how it would have increased engagement or acted as an incentive to save, particularly when only 23% of UK savers feel in control of their pension. Almost half (48%) don’t feel in control because the system changes too much.  Instead, it would have contributed to a lack of consumer confidence and engender more distrust of future governments making further changes.

¹ In September 2015 Hymans Robertson conducted two streams of consumer research. The first was qualitative: we held a series of focus groups in London and Glasgow. The second was an online survey of over 2000 people, which further tested the findings of the focus group sessions with a broader audience

² A poll of 75 blue chip employers conducted by Hymans Robertson