Pensions Tax Policy - where from and where next?
Life used to be simpler. 100 years ago, a ground-breaking piece of legislation – the Finance Act 1921 - enacted the framework for pension tax relief which remained broadly intact for most of the 20th century. Pensions policy was admirably clear. Saving for retirement was to be encouraged so that levels of poverty which had blighted previous generations of working people could be eradicated. Employers were to play a key part in that. Indeed, they were expected to do the heavy lifting needed to ensure that meaningful levels of retirement security could be achieved. It therefore made sense to allow employers to set pension contributions against their taxable profits, for employees to get tax relief on any contributions they made and for the fund in which those contributions were invested to accumulate free of tax - provided the fund was approved by the Inland Revenue.
Of course, that policy had taken time to achieve. The archives of the PLSA (formerly the National Association of Pension Funds), now held by the Pensions Archive Trust, document the struggle to convince politicians and the Inland Revenue. That it succeeded against the backdrop of the First World War and the social, economic and political upheaval which went with it, is a tribute to the vision and persistence of those early employers who wished to build on the charitable impulses which had already led to the formation of funds such as those of Reuters in 1893 and WH Smith in 1894.
Other familiar names across a variety of sectors had established pension arrangements before 1921 - Boots, Cunard, The Times Newspaper, Bournville and Royal Mail along with a host of others - but the new tax regime encouraged many more. Employers continued voluntarily to set up and improve new schemes throughout the inter war years and for much of the 20th century.
As Revenue approval was necessary to secure tax relief, the requirements of the Revenue dictated the structure of the pension funds which were set up. Almost all occupational schemes set up at this time were established under trust. The advantages of separating pension assets from the employer’s resources and placing the funds under the stewardship of trustees may seem obvious - but it was the Revenue requirement that schemes be set up under irrevocable trust which shaped the pensions landscape until comparatively recently.
For the self-employed, tax relief on pension contributions was also available. Specific percentages of tax allowable contributions were set out, broadly increasing with age.
Tax policy remained stable for most of the century with one or two exceptions. Two particular changes however highlighted themes with which we are increasingly familiar. The first is Treasury concern at the cost of pensions tax relief; the second the ability from a practical and political viewpoint, of removing or modifying those reliefs.
The 1980s were a decade in which many final salary occupational schemes were in surplus. Keen to ensure that employers were not using excessive pension contributions to shelter corporate profits, the Finance Act 1986 required surplus beyond specified levels to be reduced by contribution holidays, benefit improvements or, exceptionally, by the return of excess funds to the sponsor in whose hands it could be taxed. Many of the arguments about the part that contribution holidays played in the under-funding of final salary schemes which emerged as the economic wheel turned have their roots in this change of tax policy.
To the general public listening to the 1997 Budget, the change in advance corporation tax (ACT) relief must have been a technical and little understood measure that was of less interest than the cost of petrol or beer. Finance directors and pensions professionals understood the implications better. It has been estimated that the withdrawal of ACT tax relief cost pension funds £117.9 billion between 1997 and 2014. Many professionals working at the time were conscious of an almost immediate change in how some corporate managements were regarding their pension schemes. If a long-established framework could be changed in this way without consultation, might other changes be on the way? Could there be a further material increase in pensions cost and risk as a result? And what about savers in money purchase schemes whose returns were directly affected? No wonder this measure is regarded by some as the ultimate stealth tax, little regarded by the public at the time but having major consequences.
Further significant changes to pensions tax were announced in the 2004 Budget. These took effect on 6 April 2006, the so-called tax simplification or A Day. A single universal tax regime was created for both occupational and personal pensions, with limits on tax relievable retirement savings controlled by an Annual Allowance and a Lifetime Allowance. The level of both Allowances has been gradually reduced in the years since 2006 as the cost of tax relief continues to be a live issue. The Annual Allowance in particular has been subjected to rapid and substantial change.
Pension tax relief in one form or another comes up as a topic for debate at almost every Budget as rumours of possible changes invariably surface. Discussions on this topic now routinely include a consideration of fairness in the distribution of tax relief. Is it fair that most tax relief goes to higher rate tax payers? Is there a case for a rebalancing, perhaps by only allowing relief to be claimed at the basic rate? But if pension saving is to be encouraged why penalise higher rate tax payers? And fairness means different things to different people. A universal limit of tax relievable pension benefits applying to everyone – surely that’s fair? Not according to some public sector workers, enraged that their final salary benefits are subject to the same tax constraints as other people’s. Just ask a medical consultant. Fairness truly is in the eye of the beholder.
A number of valiant attempts have been made to try and bring some clarity into future policy making in this area. In February 2021 the PLSA published a discussion paper entitled Five Principles of Pension Taxation. It proposed that if any reform of pensions tax relief was to be attempted, it should be based on the following principles. These were:
- that any new system should provide financial support and incentives for saving
- that it helped savers make the right decisions about retirement saving
- that it helped everyone, whether employed, self-employed and non-workers (their terminology) save for retirement
- that it was simple and minimised cost, and
- that it was designed to avoid repeated change and helped to build confidence in long term saving
It is difficult to quarrel with any of these as general principles. Perhaps, though, the most important is the fifth and last principle. We have seen that pensions tax policy can change the way employers and others behave. One of the resounding achievements of the 1921 Finance Act was to establish a framework which gave stability and confidence over many years, leading to a huge advance in meaningful pension provision for more people. Times change. But not the need to set clear long term policy objectives and an implementing framework to support them.
Director Pensions Archive Trust