Pensions World

Maybe it is time to abolish tax relief on pensions, suggests Anthony Hilton, Evening Standard

At a pensions conference recently the audience of trustees, consultants, managers and assorted hangers-on was asked, by means of these now ubiquitous key pad voting devices, whether it thought pensions saving should continue to attract tax relief. A year ago the question would not have been asked. Today, with the government set to restrict the tax relief available to high earners, and in some cases to tax pension contributions as a benefit in kind, it is uncomfortably topical. The audience voted over 70% in favour of the continuation of unrestricted tax relief. It was perhaps the least unexpected of all the votes which took place that morning. It underlines just how central tax relief on contributions is to the pensions industry. People cannot imagine the industry without it – and see no reason to try.

Discrimination

Perhaps it is time that they did – not because the attack at the top end may turn out to be the thin end of an ever larger wedge, but because the distortions caused by tax relief may have got to the point where they outweigh the benefits. Today’s unthinkable question is whether it might actually be better if tax relief on individual pension contributions were abolished.

Economists have no doubt about such things. They believe in fiscal neutrality, by which they mean that the tax system should not discriminate in favour of one form of saving over another. If it does, it causes distortions and inefficiencies and interferes with market mechanisms and the free flow of capital. Their suggestion would be that all saving gets tax relief or that none does.

The only reason for encouraging pension saving would be if it could be scientifically proved somehow to be better from an economic or a social perspective than any other form of saving. No one has ever done that. A political preference is not a proof.

Those of us in the real world have a rather different view. The main problem with pensions saving in the UK is its complexity. There can be no area of personal behaviour where there is such a huge amount of legislation. And it is the tax relief and the desire of the authorities to avoid the exploitation of tax loopholes which drives the complexity.

Much less transparent

Three things flow from this. First becoming a saver through a pension scheme is complex and restrictive. To take just one aspect, the huge deterrent to pension saving is the fact that the saver cannot get at the money for decades. The lockup makes pension saving unsuitable for a lot of low income people. Without the reliefs, pensions could be at least as flexible as ISAs.

Second the complexity adds hugely to the costs of running the schemes. The burden of compliance eats up money and means there is less available to be spent by the members.

Third the tax relief muddies the waters and makes the system much less transparent. The charges levied by investment managers on pension schemes are believed by many to be too high and the value added by the fund manager too low. In a recently published paper for the Tomorrow’s Investor project, David Pitt Watson, a manager with Hermes, argues that a charge of just 1.5% a year over 40 years would reduce the resultant pension income by 40%.

Others say that almost all the investment gains get absorbed by fund management charges, leaving the tax relief as the only source of gain to the saver. If that relief were not there, the interaction of fund management costs and performance would be more visible and fund managers would have to raise their game.

So next time you are asked to vote on tax relief, pause for a moment and ask yourself if it really does help the industry.

Anthony Hilton is financial editor, Evening Standard; anthony.hilton@standard.co.uk