The Institute for Fiscal Studies (IFS) has published a blueprint for a better tax treatment of pensions, setting out how the tax and National Insurance Contributions (NICs) treatment of pensions might be reformed to more equitably support pension savings.
The IFS favours replacing the tax-free lump sum with a government-funded taxable uplift (6.25%) on, say, the first £400,000 of withdrawals of pension. This, it says, would be equivalent to restricting the 25% tax-free lump sum to the first £400,000 of pot value (to avoid further rewarding pension saving where people already have significant sums put aside) and limiting the tax saving to that enjoyed by someone who would otherwise pay 20% tax on this income. The IFS suggests that more generous top-ups could be considered where the pension provides a secure income for life.
The IFS also suggests overhauling the NICs treatment of pensions. Employee contributions would be made exempt from employee NICs, although these would subsequently be payable on private pension income. This would be a reversal of the current system, bringing it into line with the tax treatment. It might also be seen to be fairer on employees who make contributions during their working life which attract the main (12%) rate of NICs. These people would receive 12% NICs relief up front and, when they withdrew their pension, only those withdrawals above the primary threshold (currently £12,570 pa) would be subject to employee NICs. Typically, some, and potentially all, of their pension withdrawals would be free of employee NICs.
Employer pension contributions would become subject to employer NICs (currently they are exempt), with a separate subsidy applied. The value of this subsidy would be a conscious political choice, rather than being an indirect consequence of decisions the Government makes about the design of National Insurance.
The IFS blueprint criticises the commonly aired proposal for a flat rate of upfront tax relief on pension contributions as being both wrong in principle (assuming that people should be allowed to smooth income, and associated tax liabilities, over their lifetimes) and very difficult to apply to defined benefit (DB) schemes.
It proposes that DB provision should be controlled by a lifetime benefit allowance (rather than the current hypothecated benefit value within the LTA) and defined contribution (DC) savings by a lifetime contribution allowance.
Finally, it suggests removing the current income tax exemption on bequeathed pensions where death takes place before age 75 and moots that all pension lump sum death benefits should fall within the scope of inheritance tax.
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In amongst the plethora of information issued by the Department for Work and Pensions on 30 January 2023 was its response to the consultation on ‘Broadening the investment opportunities of defined contribution pension schemes’ together with revised statutory guidance. The government seeks to introduce ‘disclose and explain’ requirements in relation to illiquid investments and to introduce an exemption from the charge cap for performance-based fees. Both will apply to occupational pension schemes providing any non-AVC money purchase benefits (DC schemes).
Trustees of DC schemes will need to disclose and explain their policies on illiquid investments in the Statement of Investment Principles (SIP) relating to their default investment choice. As Collective Defined Contribution (CDC) schemes do not have to provide a default investment choice, the main SIP should disclose the trustees’ policy on illiquid investments. They must also calculate the percentage of relevant scheme assets within each default fund allocated to different asset classes and report the results of their assessment in their Chair’s Statement. The Government’s objective is to improve the information available to members and employers so that they can see “where investments are being made and the justifications for this” and to ensure that trustees “explore a fuller range of investment products and opportunities” with the potential for better longer-term net returns. The Government has added a requirement requiring it to report to Parliament on the extent to which its policy objectives have been achieved within five years of the regulations coming into force.
The definition of “illiquid assets” used is “assets of a type which cannot easily or quickly be sold or exchanged for cash and, where assets are invested in a collective investment scheme, includes any such assets held by the collective investment scheme”. It aims to ensure all current illiquid assets are covered, but at the same time the definition remains flexible enough so that the industry can continue to innovate.
Final draft regulations (amendments to the Investment, Scheme Administration, Disclosure and Charges and Governance regulations) are still awaited, but are expected to take effect in April 2023, with the requirement to report the new asset allocations in the chair’s statement for the first scheme year which ends after 1 October 2023. Any revisions to a default SIP after 1 October 2023 must incorporate the trustees’ policy on illiquid investments, with an ultimate deadline of 1 October 2024.
The Government also confirmed it is proceeding with the introduction of an exemption for ‘specified performance-based fees’ from the charge cap that applies to default funds with the proviso that higher fees are only justified as a result of higher returns. While the DWP has made a number of technical changes to the measures as result of industry responses received to the consultation, the underlying objective remains. Despite the lengths to which it has gone to allow trustees to consider paying higher fees, the DWP makes clear that this places no obligation on them to invest in assets that come with performance fees and stresses that it does not interfere with trustees’ fiduciary duties. It is also worth noting that measures allowing schemes to pro-rate the effects of performance fees for charge cap purposes are repealed.
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