Targeted ISAs and working for longer in think tank's vision of pensions by 2020

Out-Law Analysis | 15 Oct 2015 | 10:05 am | 3 min. read

FOCUS: People could be using multiple individual savings accounts (ISAs) to put money away to meet all their future needs by 2020, if a vision of the future set out by a Conservative-leaning 'think tank' comes true.

The ISA-centric world envisaged by the Centre for Policy Studies (CPS) in a new policy paper (32-page / 420KB PDF) would be simpler and more efficient, with tax relief distributed more fairly. Savers would have multiple ISAs to meet different needs throughout their lives: a pensions ISA, a lifetime ISA, even an ISA for care home fees.

The current pensions annual and lifetime allowances would be abolished and replaced by a single, £8,000 annual tax free allowance, covering individual, employee and employer contributions across multiple saving strands. And all of this would be done on one 'big bang' transition date when, like the dinosaurs before them, the old world of pensions would die.

The tax landscape

Currently, saving into a pension is tax free as are, for the most part, any investment returns over the lifetime of the pension saving arrangement. The actual pension income is taxed. This system is referred to as 'exempt-exempt-taxed', or EET for short. ISAs, on the other hand, are taxed on a TEE basis, where saving into the ISA is taxed but then returns and withdrawals are tax exempt.

From the Treasury's perspective, a shift to TEE is an attractive prospect. Under TEE, the Treasury will be able to accelerate its tax receipts by a generation. By ending pension tax relief, the Treasury will no longer be required to wait until people retire in order to recoup its share of tax, instead receiving this at the point of saving. The initial transition from EET to TEE could also net a significant windfall for the Treasury, resulting in what the CPS paper describes as a "significant reduction" in the UK budget deficit.

The CPS paper proposes that the Treasury adopt a 'big bang' approach for simplicity's sake, by naming a date on which EET would end in respect of all future contributions. Pension savings currently in existence could either become TEE at this point, or remain taxed at the point of withdrawal. The first option would not amount to an 'EEE' windfall for savers though, as pension schemes would be required to transfer assets to the state in respect of previously paid tax incentives. A tax charge of 17.5%, as proposed by the CPS, would "trigger a huge one-off cash flow" for the Treasury, given the approximately £2 trillion currently held in pension assets.

Public sector schemes and the remaining defined benefit (DB) schemes in the private sector are seen by the CPS as the most likely area of potential transition difficulty. The changes would either result in significant tax bills for members and schemes to offset the far lower £8,000 allowance, or alternatively force the issue of whether public sector workers should be able to continue to accrue DB pension rights in an environment where "the private sector is almost a DB desert". In other words, DB could end for everyone.

The impact for you and your staff

A sub plot of the paper is that employees would have to work for longer under the new system. The CPS recommends that employees be prevented from accessing ISA savings intended for retirement until the age of 60 by 2020 and 65 by 2030, instead of the current age of 55. Savers could, perhaps, be allowed to access their actual contributions but not any employer contributions, subject to paying back any Treasury incentives.

Under the system proposed by the CPS, employer contributions would be treated as part of an employee's gross income and taxed. Pension contributions themselves would not get any tax relief, but instead the Treasury would pay in an incentive of 50p for every £1 saved up to an annual allowance.

The lifetime allowance, which is currently £1.25 million, and the annual allowance of £40,000 would be replaced with a simpler, roll-forward annual allowance of £8,000. The paper also subtly hints at increasing auto-enrolment contributions by upwards of 6%, presumably split between employer and employee. Salary sacrifice would be abolished. In this new world, employees and employers would end up paying more.

The paper also discusses incentivising people to take annuities, or annuity-like products, with their ISA savings from the age of 60, due to the "individual and societal benefits" of annuities. It suggests a Treasury-funded 25% income uplift or even the ability to get an annuity from the Post Office or National Savings. The CPS says that people "like" annuities, but "just do not know it".

The CPS describes itself as being independent, but has strong links with the Conservative Party. Given that its paper follows on from the Treasury's recent call for evidence in respect of a future tax regime for pensions, it may offer an insight into things to come.

Nick Stones is a pensions law expert at Pinsent Masons, the law firm behind Out-Law.com.