TEE is not the answer to strengthening the incentive to save
Under-saving for retirement remains a perennial challenge, which may explain why pensions system reform remains high on the UK Government's agenda, reports Christine Scott.
In this summer's emergency Budget, the Chancellor announced that pensions tax relief is the next part of the system to be considered for a radical overhaul. This was followed by a hastily published consultation from HM Treasury on the merits of abolishing tax relief on pensions saving in favour of tax free retirement income.
In its response to the consultation 'Strengthening the incentive to save' PDF [123 KB], the ICAS Pensions Committee sets out its concerns about such a move and questions whether a lack of awareness about the availability of tax reliefs provides sufficient justification.
The current model for pensions tax relief works on the basis that pension contributions and investment gains and returns are tax exempt while retirement income is taxed: this is known as an Exempt, Exempt, Taxed (EET) model.
The UK Government is now toying with the idea of removing tax relief from pension contributions and exempting retirement income from taxation instead: there are no plans to change the tax treatment of investment gains and returns on pension savings. This is known as a Taxed, Exempt, Exempt (TEE) model, which many savers will be familiar with as the model used for Individual Savings Accounts (ISAs).
Transitioning from an EET model to a TEE model would be exceedingly complex, with people likely to find it harder to manage their tax affairs on retirement through having a combination of taxable and non-taxable retirement income. The impact of the loss of tax relief on defined benefit (DB) schemes, which are open to future accrual and their sponsoring employers, is also a significant concern.
We believe that the EET model has the potential to provide an incentive for more saving, especially in an auto-enrolled environment; therefore we would prefer to see further efforts by Government to raise awareness of the availability of tax reliefs rather than a change in the model.
The EET model has another distinct advantage over the TEE model in that it should help preserve pension pots through acting as a break over cash withdrawal. This in turn supports a culture of saving towards an adequate income in retirement. Introducing a TEE model alongside the recent pension freedoms could be detrimental to the Government's aim of better retirement incomes for all.
There is tension between the cost of pensions tax relief to the Exchequer and the pensions reform agenda which is designed to encourage individuals to save more for retirement; in summary, the more people save the greater the cost of pensions tax relief.
The way of addressing the tension between these two matters is to find the most effective way of targeting tax reliefs. This is in essence what the Government is seeking to resolve but the consultation paper has not been developed in a way which reaches the heart of the matter.
Now that major reforms to our pensions system have been implemented, it is an appropriate time for the Government to consider setting up an independent pensions/ retirement savings commission as a standing advisory body which seeks to achieve long-term stability for the UK pensions system and cross-party consensus.
ICAS response to ''Strengthening the incentive to save'