EET your TEE
The review of pension tax relief is a profound opportunity to change the way people save
“Eat your tea, or you won’t get dessert.” It’s a bargain that every parent has offered at some time or other. The dessert is a reward for doing the right thing. It is not an incentive to eat the meal. If it was, parents would never have to use it as a bribe.
It’s the same with tax relief. If tax relief was an incentive to save then would we have needed auto-enrolment? Tax relief, like dessert, is a reward for doing the right thing. But the debate on the future of pension tax relief risks being concentrated on EET and TEE, and not the rewards for pension saving.
Saving for retirement is a long term game that requires a reward. The present system offers tax relief on the contributions paid into a pension but, unlike dessert, tax relief is poorly understood. It simply doesn’t work in its existing form. The current rewards for saving focus on those who are most likely to save and we’re left with a system which most benefits the wealthiest.
Any reformed system of pension reward needs to provide three things: a clearer focus on outcomes, inter-scheme fairness and inter-generational fairness.
If the debate around the rewards for pension saving have been scarce, then the debate about outcomes has been non-existent.
The reward for pension saving must be defined, but equally so must be the outcome that is desired.
We would argue that the government needs to articulate what its objective for the pension tax system is in terms of delivering an outcome. Delivering this outcome might be through matching contributions or preferential tax rates, but if we have a specific outcome in mind, we at least have a chance of hitting it!
There is a need for savers in schemes of all types, be they DA, DB, or DC, to be rewarded to achieve the desired outcome. The present system of allowances is far more generous to savers in DB schemes than to those in DC and this just exacerbates the inter-generational unfairness that is rife in our pension system today.
Reform of tax relief must recognise that a great many savers of all types have already benefitted from tax relief. There are few who would trust their retirement wellbeing to the whims of a Chancellor who might not yet be born.
For example, would a government far off in the future be tempted to start taxing pension saving if there was a move to TEE? What would this do for trust and confidence in retirement savings for future generations? In a TEE world is it sustainable not to tax pensions when we have an ever increasing pensioner population compared to those of working age?
The review of pension tax relief is more than just an issue of tax. It is an opportunity for pensions to achieve a target and a consumer focussed purpose that has been missing since the demise of private sector DB. It is important to look beyond the debate about EET and TEE and to think about the objective of pension saving.
Then, perhaps, we can have ice cream.
Darren Philp is director of policy and market engagement for the People’s Pension.