For £300bn, what would the Chancellor not do to the pensions system?

Can the Chancellor really resist a £300bn pensions tax relief windfall by switching to TEE? John Greenwood investigates 

Any review of government policy that can not only influence the spending of £50bn a year of tax relief but also create a one-off windfall in excess of £300bn is always going to attract the Chancellor’s attention. So it is no surprise that the Treasury is taking a very close look at the possibility of rewriting from scratch the entire pensions incentive system.

More than a few eyebrows have been raised at the title of the paper – Strengthening the incentive to save: a consultation on tax relief – which many think masks the real intention, saving cash, or at the very least, ensuring the cost of relief for the 10 million or so new auto-enrolment savers doesn’t break the bank.

The choices on the table range from doing nothing, through manipulating existing thresholds, right up to the nuclear option of moving from an Exempt, Exempt, Taxed framework to a Taxed, Exempt, Exempt one.

Aviva head of policy John Lawson argues the government can control the annual pensions tax relief bill equally well through the current EET system as through a radical and potentially painful switch to TEE. “You can pull the levers to get the number you want through each system equally easily. Under the EET system it would probably make more sense to move the rate of relief, switching to a flat rate of tax relief, to make savings, rather than continuing down the route of cuts to the annual and lifetime allowance.

“Switching to TEE without including DB would not save the government as much as it thinks as two thirds of tax relief goes to DB pensions. But including DB would be very complex and potentially unfair as how do you deal with deficits which were established when tax relief was available?”

Lawson adds that some form of incentive would have to be given to savers to get them to tie up their money for decades, further reducing the net saving.

The idea of a switch to TEE has been floated by Michael Johnson, the Centre for Policy Studies fellow who has published a number of papers on the subject. Johnson’s terminology is all over the consultation paper. He points out that over the last decade the pensions and investment industry received around £270bn in tax relief contributions from the Treasury which has sat in pots being managed with charges being accrued.

But he is also adamant that the one-off saving made by moving tax relief from today to the future is so great that the government could make fundamental, epoch-marking inroads to its fiscal challenges.

“This could be the great trade to be done,” says Johnson. While the government can tailor ongoing cost savings equally easily through EET and TEE, it is the one-off saving that moving from one to the other that is surely getting the Chancellor’s pulse racing. A one-off tax raid on all the money in pensions, claiming now what would have been claimed in retirement, would transform the nation’s finances.

For all of us who have grown up under the current system, comprehending just how we could shift to a TEE basis without creating massive complexity is an uphill task. Either two systems would have to run in parallel or, as has been hinted by the Treasury, the entirety of today’s accrued pensions would be re-revalued to a TEE basis on a single day. This latter route is the one that offers the mega cash injection to the Treasury.

“Osborne has this idea of turning the £2 trillion in pensions that has been accrued on an EET basis and moving it to a TEE basis and raising £300m in the process,” says Hymans Robertson partner Chris Noon. “Re-evaluating this across the board would create lots of winners and losers and it would take an incredibly long time to do.”

That £300bn – yes billion, not million – is based roughly on the 20 per cent income tax that would be paid by most, less tax-free cash, on the £2 trillion assets in the industry.

The idea of state intervention pensions is not without precedent, even within the EU. Hungary took pension assets into state control earlier this decade. A move to TEE would not be quite so radical, as only the tax relief would be taken, or an equivalent to make it so that the tax relief situation stayed broadly the same when it was given back at a later date, the politicians would argue, leaving the punter having lost nothing. A big here question is, would the public trust future governments to leave income untaxed?

Towers Watson senior consultant David Robbins says: “The government would presumably have to give some form of matching contribution to incentivise people to save in the new arrangement, otherwise they might as well just save in an Isa where there is full access. But it would involve the public trusting the government not to come back and tax them again years down the line when they come to retire. Bringing forward tax revenues to make the nation’s accounts healthier could lead to greater public spending today, storing up more problems for the future, when there will be less working taxpayers to cope with them.”

But is it so fanciful that Osborne would be put off by such considerable but arguably not overwhelming considerations when the prize, a massive reduction in the country’s debt levels, is so great? The EET to TEE one-off cost saving is so tempting that it is hard to call whether the Chancellor will be able to resist it. And if not, it has created such a wave of panic through the industry that the idea of flat-rate tax relief suddenly seems mild by comparison.