Corporate Adviser editor John Greenwood’s submission to the Pension Schemes Bill Committee, to which he gave evidence as a witness on 23rd October 2014.
1. I am editor of Corporate Adviser magazine, a magazine for pensions consultants. I am also the author of the FT Guide to Pensions and Wealth in Retirement, former deputy personal finance editor of the Sunday Telegraph and a frequent freelance to several national newspapers.
2. The unprecedented liberalisation of the process for withdrawing pensions, outlined in the Budget 2014 and taken forward within the Pension Schemes Bill, creates huge new areas of potential tax leakage that appear to have been completely missed by the Treasury, the Office for Budget Responsibility and those advising them. It is in this area that I believe I have information and understanding that will be of particular interest to MPs debating this bill.
3. The Treasury’s prediction of £3bn extra tax revenue resulting from its freedom and choice in pensions policy, set out at Chart 1.11 in the 2014 Budget document, appears wildly inaccurate – I believe the Treasury will lose much more money than it will gain. I also believe the Budget papers show the Treasury was not aware of this issue at the time the Budget was delivered.
4. The freedom to access pots entirely once an individual reaches age 55, creates an opportunity for anyone over that age to avoid liability for both employer and employee National Insurance, as well as income tax.
5. I calculate that in excess of £20bn could be lost in the first year of this new policy if everyone over 55 takes advantage of this new option. I have presented this figure to numerous experts in the pensions industry, and none have suggested that the potential loss is not of something of that order. In the course of my job I regularly speak to the most senior professionals in the pensions industry and I am yet to get a kickback on the figures I have put forward. I do not believe that everyone over 55 will take advantage of this loophole, but even if 10 per cent do, that is still a £2bn loss in the first year, a considerably worse outcome than the £300m net gain predicted by the Budget documentation.
6. The Treasury has published measures to restrict tax leakage, which by my reckoning reduce the potential loss per year to around £10bn a year thereafter. But the Treasury’s attempt to close the loophole – the reduced annual contribution allowance of £10,000 pa for anyone taking pension benefits – only reduces the potential for tax leakage for the 2016/2017 tax year – it does virtually nothing to limit tax losses of up to £20bn in the 2015/2016 tax year.
7. Here is how it works – under the current rules individuals over age 55 can start drawing their benefits, but, tax-free cash aside, they can only draw cash out at a rate prescribed by the Government Actuary’s Department, because pension must be paid as income. Therefore, anyone who opts to have their entire salary (less minimum wage, which must be paid by law) into their pension, can build up a big pension pot and will avoid a lot of employer and employee NI, but will not have enough to meet their day-to-day expenses.
8. Under the new rules employers can choose to pay employees into two pots, both of which have complete access for those over 55 – salary into the current account or pension into the newly flexible pension account.
9. Payments made through the salary channel attract employer NI of 13.8% on everything over £7,956. Employees also pay NI of 12% on everything over £7,956. And employees pay income tax on the entire amount.
10. Payments into pension are free of both employer and employee NI, and a quarter of them can be taken as tax-free cash.
11. Salary sacrifice for pension contributions is legal and the strategy of maximising it has been used for years by senior executives looking to boost their pension contributions in the year before retirement – they have been able to do this under current rules because they tend to have other money to live off, so don’t need the income.
12. Salary sacrifice for regular pension contributions is used by a very large proportion of large and medium-sized companies, as well as DB schemes.
13. By opting to be paid through pension via salary sacrifice rather than 100 percent through salary, an individual on £40,000 could cut their total tax and NI bill almost in half, from £9,845 to £4,997. Factoring in lost employer NI, the total cost to the Revenue would be £5,484, a loss off 62 per cent.
14. I originally estimated the total potential tax loss figure, with assistance from industry professionals, at £24bn, a figure that appeared in the Telegraph newspaper on May 29, 2014, but I believe that £20bn is probably closer. This is on the basis of every one of the 5m or so people over age 55 and below state pension age taking advantage of the loophole.
15. Clearly not everyone will do this – many employers will baulk at the complexity. Larger employers may decide it sounds like a wheeze and be worried about reputational risk. But I speak to corporate pension advisers on a daily basis and they say some employers, particularly SMEs will definitely want to go for this.
16. A further avenue of revenue loss is through bonuses. For anyone over, or approaching the age of 55, flushing bonuses through pension will now become the norm. Take the cash through salary and you pay tax and NI on the whole sum, but pay it into a pension and you pay no NI and a quarter of the fund is tax free, and you can still take your money tomorrow.
17. I have made at least six requests to the Institute of Fiscal Studies for some comment, reaction or perspective on the issue and the veracity of my own numbers. They have declined to put someone forward to speak to me, for reasons best known to them.
18. The Government has attempted to close the loophole while at the same time retaining the flexibility of the new reforms, which have proved massively popular with the public. But it cannot do both. Its only lever is the reduced annual allowance for those who take their cash early, but this has been designed so that it does not impact anyone but the highest earners. Earners of all income brackets can save thousands through these new rules. The Treasury’s response to the consultation on these measures actually stated that the £10,000 annual allowance would not affect 98% of the population. So by that same token, it is therefore no deterrent to people taking advantage of this tax avoidance opportunity.
19. In its response to a Freedom of Information Act request from Corporate Adviser, my magazine, for information on the costings and assumptions used in the formulation of the policy, the Treasury has said nothing that suggests it was fully aware of all the ramifications of this policy at the time it was presented to the House.
20. Corporate Adviser requested details of the assumptions made as to increased use of pension rather than salary for remuneration when calculating the effect of the policy – a strategy that would cut the state’s tax take by over £3,000 for each £10,000 channelled through pension.
21. The budget papers set out an increase in revenue of £320m in 2015/16 rising to £1.2bn in 2018/19. Clearly it has made some assumptions to get to these figures – namely that somewhere south of £3bn more will be taken out through flexible drawdown in 2018/19 than would have been the case if people were using annuities or old-fashioned drawdown, and that income tax will be paid on these sums.
22. But the Treasury has given no response to the question ‘did it spot the salary sacrifice issue’ other than ‘go and look at the Budget papers’ – specifically the budget Policy Costings document.
23. The Policy Costings document focuses solely on the number of people who access their money early. The statement ‘this leads to an increase in income tax received in early years as individuals will now pay tax on the withdrawals from their pension pot’ is the only post-behavioural costing factor referred to by the Treasury in the entire paper, other than a single line that says ‘adjustments are also made for the higher costs of pensions tax relief to reflect the increased attractiveness of pension savings for some individuals’. There is no mention of lost National Insurance.
24. Under the Policy Costings document’s heading ‘Areas of uncertainty’, reference is only made to the number of individuals making use of the new withdrawal facility, with no mention of the number of employers that could use it to cut their payroll costs.
25. The document then goes on to make the claim that the policy ‘results in increased income tax receipts in each year until 2030’, although it gives no figure for increased expenditure for pension credit and other passport benefits as people spend their money early. Australia has a similar system to that which we are moving towards. The Australian government’s Murray review of the financial system has found that a quarter of those with a pension pot at age 55 have spent the lot by age 74.
26. Detailed example – how salary sacrifice cuts the Treasury’s tax take
An employee aged 55 or older is paid £40,000 a year.
If the entire sum is paid as salary, the individual pays employee Class 1 NI Contributions at 12% for earnings above the primary threshold of £7,956, totalling £3,845.28.
He also pays 20% income tax on earnings above the £10,000 personal allowance, totalling £6,000.
Total tax paid by individual = £9,845.28
Total post-tax income = £30,154.72
AND His employer also pays employer NI contributions of 13.8% for earnings above the primary threshold of £7,956, totalling £4,422.07.
Total tax paid to HM Revenue & Customs = £14,267.35
If the individual opts to receive just the minimum wage as salary (£11,484.20 assuming a 35-hour week), and gets the balance of £28,515.80 paid into a pension, no employer or employee NI is due
From April 2015 the entire pension can be drawn immediately.
Tax on salary
The individual pays employee Class 1 NI Contributions at 12% for earnings above the primary threshold of £7,956, totalling £423.38.
20% income tax is due on earnings above the £10,000 personal allowance, totalling £296.84.
Total tax on salary £717.22
Plus the employer has to pay NI of 13.8% on earnings above the primary threshold of £7,956, totalling £486.89
Tax on pension
The individual receives 25% of £28,515.80 as a tax free lump sum = £7,128.95
The remaining £21,386.85 is liable for income tax at 20% = £4,277.37
Total tax paid = £4,997.59
Total post-tax income = £35,005.41
Total tax paid to HM Revenue & Customs (incl employer NI) = £5,484.48
Loss to HMRC through freedom and choice in pensions = £8,782.87 (62% of its revenue when paid through salary)