Is the Lifetime Isa a blueprint for a wider overhaul of the pensions system that would see tax relief abolished altogether? That is, literally, the multi-billion-pound question, and advisers, providers, employers and other stakeholders will be attempting to work out the answer in the months between now and the EU referendum at the earliest.
The idea Chancellor George Osborne wants to press ahead with a pension Isa system that sees pension contributions paid out of taxed earnings but free from tax both in the growth period and on withdrawal is pretty well established. A couple of weeks before the Budget the Treasury was widely reported to be favouring a move to the pension Isa over a flattening of existing tax reliefs: a move that would have given Osborne considerably more room for manoeuvre in his fiscal planning.
But a wave of protests, coupled with an effective Cabinet Office ban on the launch of any controversial policy until after June’s Brexit referendum, led to the Treasury hurrying out a statement that there would be no change to pensions tax relief in the Budget.
“It was clear there is no consensus,” said Osborne in his Budget speech. “So, faced with the truth that young people aren’t saving enough, I am today providing a different answer to the same problem.”
True to his word, Osborne has not changed tax relief on pensions – yet. But many in the industry believe his “different answer to the same problem” paves the way for its complete abolition.
AJ Bell head of platform technical Mike Morrison says: “We couldn’t have a pension Isa, so that means we got an Isa pension instead.”
He is, of course, talking about the Chancellor’s Lifetime Isa launch that sees under-40s allowed to save up to £4,000 a year and receive a £1,000 Government match. The entire pot can be accessed for the purchase of a first home or from age 60, or before then with the loss of the bonus, plus a “small” exit fee.
“We couldn’t have a pension Isa, so that means we got an Isa pension instead”
Morrison says: “You have to ask if, as the Chancellor said, there are no concerns there was no consensus, then why is he trying to force in a pension Isa system through the back door?”
It seems certain the Chancellor is not yet finished with pensions. The strengthening the incentive to save consultation is still hanging in the air as, while the Government published a summary of industry feedback as part of the Budget, it is yet to issue its own formal response. The launch of the Lifetime Isa has cost Osborne money, not saved it.
The Budget documents point to a combined cost for the introduction of the Lifetime Isa and the increase in the Isa allowance to £20,000 of £170m in 2017/18, rising over the next two years to £850m in 2020/21, adding up to a total of almost £2bn by the end of this Parliament. If, whenever Osborne does revisit the pension tax relief question, he was serious about a flat rate of tax relief, then it is hard to see why he would preface that with the launch of the Lifetime Isa. Instead, he is already sowing the idea that an Isa plus a contribution can be as good as a pension – ably assisted by the raft of media coverage of the “pension versus Lifetime Isa” variety.
For Hargreaves Lansdown head of retirement policy Tom McPhail, the Lifetime Isa looks like the blueprint for the future of retirement saving. He says: “This looks like the reform Osborne wanted to roll out across the whole pension system. In time he may still do so. In the short term he may still chip away at pension allowances to help balance the Exchequer’s books. In the longer term, he may look to progressively extend the Lifetime Isa until it eventually replaces the pension system altogether.”
Others believe the change will come sooner because of the pressing need from the suddenly embattled Chancellor for the huge savings that can be made by making a switch from the so-called exempt-exempt-taxed system to the taxed-exempt-exempt model.
Actuarial firm Spence & Partners founder Brian Spence says: “This is almost certainly a first step towards a move from EET to TEE. What we have at the moment seems to be set outside the pension regime. What we don’t know is how it fits in with auto-enrolment. But we can be absolutely sure pensions will be subject to further interference.”
Punter Southall principal Neil Latham agrees. He says: “The Chancellor has four years, unconstrained by the Liberal Democrats, and he is short of money. You have to think he will want to do something quite radical fairly quickly.”
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Spence says precisely where Osborne’s Lifetime Isa is intended to sit within the overarching retirement savings framework is not clear. He says: “Osborne’s commitment to auto-enrolment policy has to be questionable. The existing regime is in a mess. The lifetime allowance is complex. The current system does not work. There was an agenda to sweep that away, but that met with a backlash. What we have is a pale imitation of what was intended as a new system, although it is a good first step. But this does not seem joined up.”
McPhail points out extending the Lifetime Isa across the entire pension system is not straightforward from a legislative perspective or an operational one, particularly mid-way through the mammoth auto-enrolment project.
He says: “The Lifetime Isa can’t be a short-term replacement for auto-enrolment because the existing Government legislation is all built around workplace pensions; in the longer term, who knows?”
Centre for Policy Studies research fellow Michael Johnson has been pushing for a TEE structure for years – he had been using the term Lifetime Isa for some time before it was adopted by Osborne, and has been briefing the Treasury on modelling scenarios.
Johnson believes the Budget announcement is the latest step in a long-term transition away from pension tax relief that started with pension freedoms, and ends with the workplace Isa replacing workplace pensions, within auto-enrolment legislation. “The direction of travel is clear. And woe betide the industry if it does not have some serious conversations around these issues,” says Johnson.
“One of the industry’s immediate criticisms is saying it is terrible because the Lifetime Isa makes people opt out of auto-enrolment. This is a legitimate concern, so let’s address this in the workplace Isa. In the workplace Isa the employee pays contributions out of post-tax income, and is eligible for the incentive. This can be accessed for a house purchase, while the employer’s contribution remains within the wrapper until age 60.”
One of the reasons Johnson is so convinced the pension Isa is such a certainty is because of the chaotic and inefficient nature of the current system, where incentives are poorly understood and very unevenly spread across the population. For anyone paying 20 per cent tax in work and in retirement, pensions offer a 6.25 per cent incentive compared with those moving from paying 40 per cent in work to 20 per cent in retirement, who get the equivalent of a 41.67 per cent top-up, according to figures from Willis Towers Watson.
Worse still for Johnson is the circular nature of much of the tax relief. What is the point, he argues, for the Treasury giving 20 per cent tax relief to an individual, only to take 15 per cent back 40 years down the line?
One of the key drivers for pension tax relief change from the Treasury’s perspective is its ballooning cost as a result of auto-enrolment. The Treasury already foregoes almost £50bn a year through tax and National Insurance relief, and the arrival of 10 million new savers paying 8 per cent of band earnings makes that figure worse, not better.
Some have suggested the political challenges of taking away higher rate relief – and the tax-free lump sum – are too great for any politician to take on, raising the question of whether the Lifetime Isa will remain the go-forward solution for those under 40, while those above that age remain within the old system.
And even if the pension Isa is brought in across the board, there will always be the assets held under the old regime, unless Osborne chooses the nuclear option and goes for a one-off tax hit on the entire £1.5trn or so in pensions and moves it all to a TEE basis on a single day.
Such a move is seen as at the “very unlikely” end of the spectrum of possibility, but Morrison does see a potential option to allow assets to be transferred from EET to TEE at a tax neutral rate. This, he says, would be a significant potential future advice opportunity, although one fraught with complexity and risk.
“It may be the Government decides to allow investors to withdraw the money from the pension wrapper at an advantageous or a tax neutral rate. That may be interesting for advisers, but it will also place them at significant risk of regulatory comeback.”
So if Osborne’s Lifetime Isa is the Trojan horse into the pension tax relief system so many believe it is, does that mean the beginning of the end for the pensions system itself?
Morrison says: “Does a workplace Isa mean the decimation of the pension industry? No, it means it has to change its focus. Propositions and tax wrappers will be different, but the
basic principle of putting money away for the long term will remain the same.”
Pensions professionals will have to wait until after June’s Brexit vote before they get a hint of what Osborne’s next move on tax relief will look like. And who knows, if Brexit does not go well for Osborne, he may not even be around to finish the job.