There have been many changes to pensions over the last few years, and the bad news is that there’s even more to come. So could the PISA be the answer to all our problems?
There’s been huge speculation about the future of pensions since the Chancellor announced last year that there would be more consultation on this issue. Clearly, there’s a real need to encourage people to save for retirement by creating a simple and transparent system where individuals take personal responsibility, but on the other hand, the system must also be sustainable and costs must be controlled. If we accept that the cost of tax relief under the current system is too high, then the argument for reform becomes clearer. But the best way of going about this reform is far from obvious.
Our current system of exempt-exempt-taxed (E-E-T) means contributions and growth are tax-free whilst the pension (when it is drawn) is taxable. ISA style investments are taxed-exempt-exempt (T-E-E), meaning no tax relief up front, but tax-free growth and withdrawals. Switching would create short-term savings for the Government on tax reliefs paid into pensions which would help to control costs, providing an attractive option for the Government. However in the long term, lower tax receipts on future pensions need to be factored into the equation.
For investors the news isn’t good. Currently tax relief, at the individual’s highest rate, is added to the pension pot. Under the T-E-E proposals long-term savers lose out because of the loss of compound income on the tax relief no longer available. People will need to save more over a longer period to achieve the same pension in retirement. Would this really encourage pension savings? The pensions system has changed so often, it’s likely people will view the future of the tax-free pension with suspicion. The E-E-T system encourages people to keep their money invested over a longer period in order to defer the tax. With a T-E-E system this will no longer be the case, and they are much more likely to access their tax free pension sooner and spend it whilst the tax free status is guaranteed - potentially leaving them short in later retirement.
A change to a PISA (pensions ISA) system would also be far from simple. Would we have complicated transitional arrangements to bring existing pensions in line with the new ones, or would the two systems run side by side? How would employer contributions be taxed without seriously affecting the employee’s take home pay?
The only certainty is that there are many uncertainties if the PISA army win this particular battle…
For more information please get in touch with Jackie Hall or your usual RSM contact.