Taxation of Pensions Bill

Written evidence submitted by John Greenwood, pensions journalist (TP 10)


- It is undeniable that the new pension freedoms create the potential for avoidance of income tax and employer and employee NI on a massive scale. With full access to their pension, over 55s can be remunerated far more efficiently through pension contributions (no employer or employee NI and 25% tax-free) than through salary.

- There is no definitive figure for the full scale of the Treasury’s exposure (if everyone maximises their ability to avoid tax and NI). I calculate it as being in the region of £20bn in 2015/16. It could be £25bn, it could be £15bn. Nobody expects this entire sum will be lost to the public purse, but it is possible that at least 10 per cent of the overall exposure figure, whatever it may be, could be lost in 2015/16.

- Nowhere in the Budget or the policy costings document published alongside it is there any mention of the potential loss of NI. The Treasury’s exposure to NI loss through over-55s flushing salary through pension is five times bigger than its exposure to income tax loss through this strategy.

- The only publically available evidence of the extent to which employers and employees will exploit the tax and NI avoidance opportunities of the new rules suggests that significant numbers intend to do so.

- The pensions minister cross-examined me at length in the Pension Schemes Bill committee on my £20bn figure, but has been unable to confirm what the government’s estimate is, or even that he has seen a government estimate of the potential lost revenue through increased use of salary sacrifice. A Freedom of Information Act request made by my magazine in July 2014 asked for details of assumptions of increased use of salary sacrifice in calculating the fiscal impact of the changes. No substantive response has been forthcoming.

- These factors suggest that the government had not spotted the loophole when it launched the policy. Its attempt to close the loophole, the £10,000 annual allowance for those who access flexible drawdown is, by the Treasury’s admission, only a deterrent to 2% of the population. The limited evidence available suggests a significant loss to the public purse if the Bill goes through in its current form.

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. Some of the opinions in this submission have been included in an earlier submission to the Pension Schemes Bill.

3. 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.

4. 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, despite claims from Treasury officials and pensions minister Steve Webb to the contrary.

5. 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.

6. I have calculated 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.

7. I would caveat this statement by pointing out that I am not a researcher or an analyst. However, remarkably, no other organisation has published figures attempting to quantify the loss of NI and tax through this policy. I am happy to be corrected as to the accuracy of these figures. 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. 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.

8. I also accept a point made by David Gauke MP in a memorandum from HM Treasury to the co-chairs of the Pension Schemes Bill Committee on the £10,000 annual allowance, dated 3 November 2014, that individuals over age 55 wanting to take advantage of a full £40,000 contribution in their first year would need other assets to live on until the end of the year before being able to access their pension, because making monthly withdrawals would trigger a reduction of their annual allowance to £10,000. It is uncertain how many of these high earners would have other assets to live off, enabling them to maximise their tax and NI avoidance. That said, the effect of this factor in diminishing the potential risk to the public purse would be in some extent offset by the number of people aged 54, with sufficient savings to live off, who could exercise this strategy in the year before their 55th birthday. In fact if these rules were expected to remain intact there would be high earners opting to have increased pension contributions, in lieu of salary, for many years before their 55th birthday, depressing tax and NI receipts further.

9. But even if the risk to the Treasury is half my figure, and I am yet to hear anyone suggest this to be the case, then a 10 per cent take-up would still amount to £1bn loss in 2015/16, more than wiping out the £320 gain predicted by the Budget.

10. 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 in the 2015/2016 tax year.

11. 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.

12. 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.

13. 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.

14. Payments into pension are free of both employer and employee NI, and a quarter of them can be taken as tax-free cash.

15. 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.

16. Salary sacrifice for regular pension contributions is used by a very large proportion of large and medium-sized companies, as well as DB schemes.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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, in particular the extent to which increased use of salary sacrifice into pensions had been factored in, the Treasury cited public interest against releasing further details. The only substantive response it was prepared to give was to refer back to the documents published alongside the budget.

23. 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.

24. The Policy Costings document published alongside the Budget 2014 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, the far greater risk to the Treasury, that is central to my submission.

25. 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 or employees using it to reduce their NI and tax bill. While the Treasury’s refusal to disclose sensitive detailed predictions is to some extent understandable, the fact that there is no mention whatsoever of lost NI through salary sacrifice suggests the issue had not been spotted when the policy was published.

26. The calculations and observations contained in this submission were questioned at length by pensions minister Steve Webb MP, but he has been unable to confirm whether he had

26. Financial secretary to the Treasury David Gauke said in evidence to the committee that HMRC "would want to monitor any fiscal risks. If we identified it as something that could be costing the general taxpayer significant sums of money, that’s something we would want to address.  Clearly, it’s in the interests of the general taxpayer that it’s not exploited."

27. The Treasury’s position seems to be that the £10,000 reduced annual allowance is sufficient deterrent to stop abuse of the rules, and provided not many people do abuse the rules, it will not do anything. However, the only evidence I am aware of as to the appetite amongst employers for using the flexibilities to reduce tax and NI indicates that significant numbers of employers will do so.

28. I point specifically to two pieces of research – one by my own magazine, Corporate Adviser, and one by Jelf Employee Benefits, a pension and benefits consultancy.

29. In a poll of 39 of the UK’s leading DC pensions consultants, taken at the Corporate Adviser Summit in October 2014, two thirds said they predicted at least 10 per cent of the available NI and income tax that could be avoided by over-55s flushing cash through pensions rather than salary would be avoided, with 35 per cent thinking more than 20 per cent would be. More than half of those present expected at least some of the employers they advise to take advantage of the opportunities for tax and NI avoidance presented by the April 2015 changes in access to pension assets.

30. Corporate Adviser Summit Survey results:

Assuming £20bn or so of NI and income tax can be avoided by over-55s flushing cash through pension rather than salary in 2015/16, what proportion of that figure will be avoided?

1. None                                   0

2. 0-10%                                  32           

3. 10-20%                        26

4. 20-30%                        18

5. 30-40%                        11

6. 40-50%                        3

7. More than 50%             3

Do you expect any of your employer clients to flush more over-55s pay through pension rather than salary as a result of the freedom and choice in pensions changes?

1. Yes            53%                        53%

2. No            47%                        47%

31. A survey 192 employers with between 50 and 2,000 employees carried out by Jelf Employee Benefits found at half are looking to exploit tax advantages arising from the new pension freedoms. In the survey, which was carried out in July 2014, 35 per cent said they would offer all of their older workers greater remuneration flexibility so that they can benefit from the new freedoms, while 15 per cent said they would consider doing so for some employers on a case-by-case basis. Only 6 per cent said they would not offer this option, with 44 per cent undecided.

32. It is clear some employers intend to use the new flexibilities to reduce tax and NI. The Treasury appears to be saying it will allow this to happen until losses are significant. However, if and when the Treasury does decide to clamp down on abuse, is not clear what abuse is or how it can tighten the rules without affecting existing pension provision that has been set up in good faith under the current outgoing rules. Employers currently have no idea what is permissible under the rules and what is not. But relying on both employers and employees not to take advantage of significant tax and NI savings seems foolhardy.

33. It is worth highlighting to the Committee the suspicion I have that the Government had not spotted the potential loss of NI and tax through increased salary sacrifice through pensions at the time the Budget was published. The pension flexibilities are extremely popular with the public, and restricting them would reduce that popularity. It is possible that Government reluctance to rein in the flexibility of a popular policy is outweighing its need to protect the public purse. My exchanges with the Government on the scale of the potential loophole, and its likely uptake, as set out below, suggest it was not aware of the problem. The reaction to the evidence I gave on these numbers to the Pension Schemes Bill committee on 23rd October 2014 has reinforced this view. In that session pensions minister Steve Webb cross-examined me at length on the accuracy of my numbers. On 11th November 2014 I interviewed him for an article for my magazine and asked him five times whether he had seen a Government estimate of the extent of the potential for loss of NI and tax through increased salary sacrifice into pensions and he refused to reply. He was unable or unwilling to confirm he has seen a figure for the Government’s estimate of potential leakage through this strategy.

34. Pensions minister Steve Webb told the Pension Schemes Bill committee that within days of the 2014 Budget "Paul Lewis of Moneybox was highlighting exactly the potential for cycling money around in this kind of way". I have contacted Paul Lewis and he has confirmed he did not look at NI loss through salary sacrifice at all – he just looked at tax loss. In the scenarios I have laid out, the loss to the Treasury of NI is five times bigger than the loss of income tax for basic rate taxpayers. Paul Lewis’s account would appear to contradict the minister’s submission to the Committee that this is something the Treasury and DWP have known about all along. This view is reinforced by the fact I have made repeated requests of Treasury and DWP for details of their assessment of the potential NI loss since May 2014 and have still received no substantive response.

35. The Government’s approach seems to be leaving many billions of pounds worth of tax and NI relief on the table and hoping take-up of it will be minimal. The only thing stopping advisers and employers from establishing structures to maximise this loophole is the threat that if they do so in large numbers, they will be stopped from doing so.

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)

November 2014

Prepared 18th November 2014