Strengthening the incentive to save: a consultation pensions
tax relief
Submission to HM Treasury
Chartered Institute of Personnel and Development (CIPD)
September 2015
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Background
The CIPD is the professional body for HR and people development. The not-for-profit
organisation champions better work and working lives and has been setting the
benchmark for excellence in people and organisation development for more than 100
years. It has 140,000 members across the world, provides thought leadership through
independent research on the world of work, and offers professional training and
accreditation for those working in HR and learning and development.
Our membership base is wide, with 60% of our members working in private sector services
and manufacturing, 33% working in the public sector and 7% in the not-for-profit sector. In
addition, 76% of the FTSE 100 companies have CIPD members at director level.
Public policy at the CIPD draws on our extensive research and thought leadership,
practical advice and guidance, along with the experience and expertise of our diverse
membership, to inform and shape debate, government policy and legislation for the benefit
of employees and employers, to improve best practice in the workplace, to promote high
standards of work and to represent the interests of our members at the highest level.
The CIPD’s interest in pensions
Within their organisations, many CIPD members have responsibility (sole or shared) for
the selection, communication and administration of contract-based defined contribution
(DC) pension schemes.
Their responsibilities include: selection of the pension scheme; decisions over fees and
charges for the default and other funds; transfer of the appropriate HR and payroll data in
the format required by the pension provider; educating employees and communicating with
them about scheme details and the importance of saving for retirement; helping
employees to value and appreciate the employer contribution; and dealing with member
queries, as well as directing them to relevant sources of further information, advice and
guidance.
For our members, workplace pension schemes are an important part of both their
employee wellbeing and talent management strategies. That is why around three fifths of
pension contributions to DC schemes in the private sector comes from employers. Any
proposals to change how pensions in general, and DC pensions in particular, operate will
have a significant impact on the value of such schemes in recruiting, retaining, developing,
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deploying and exiting staff, as well as on the work opportunities sought by older
employees. Any alterations to workplace pension procedures and outcomes will have an
influence on how employees perceive the value of saving for their own retirement.
Given their responsibility, our members are uniquely placed to understand why employees
contribute what they do and how they respond to various pension messages and
education. If the government wishes the HR profession to play a significant role in helping
their employees save for the future, then it would be wise to listen to their view and
opinions.
The CIPD’s response to this consultation is based on a survey of 115 people management
professionals. Most respondents (78%) are HR or reward practitioners, the rest are
consultants - either HR generalists or reward specialists - (14%), or are payroll or pension
professionals (8%). Most (63%) practitioners work for a large employer, based in the
private sector (75%) and operate an open defined-contribution scheme (95%). Some
respondents (44%) have a defined benefit plan, but most of their plans are closed to new
or future accrual (64%), the ones that are open are focused in the public sector.
In addition, we have held a workshop for senior reward professionals to talk about some of
the implications from the consultation in more depth and to discuss the responses from the
survey. The workshop attracted participation from organisations such as Associated British
Foods, Barclays, Thomson Reuters, the London School of Economics and Political
Science, Legal and General, Sony and Unipart.
In summary, the CIPD’s position is:

that now is not the time to change the pension tax-system; and

an independent commission should be established to make workplace pension policy,
so reducing the incentive for policy makers to tinker with the system
If the Government has to change the existing tax relief arrangements for pension
contributions, the CIPD believes that the following changes would be least unfavourable:

there should have one rate of tax relief for all employees rather than TEE, which would
reduce employee and employer contributions and be complex to administer;

if the lifetime allowance could be scrapped, we would support the annual allowance
being brought in line with average earnings

the amount of pension that is paid tax-free could be limited; and

sufficient time is given to allow stakeholders to update their policies and procedures.
Our response to the questions contained in the consultation are as follows:
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Response
1. To what extent does the complexity of the current system undermine the
incentive for individuals to save into a pension?
The consensus amongst survey participants and workshop attendees is that, for most
employees, complexity is not an issue. Instead, complexity is typically far more of an issue
for higher paid employees, regarding issues such as the annual and lifetime allowances,
and the additional rate earners’ taper tax relief.
The belief is that what gets both young employees and low and moderate earners into a
workplace defined contribution (DC) pension scheme is automatic enrolment, and what
keeps them in it currently is a combination of salary sacrifice and inertia. However, there
are concerns that among those employees who have been automatically enrolled at the
minimum level, some may opt out subsequently as they are required to contribute more.
The extent to which they do so over the coming years will depend on the Government’s
economic strategy over the next few years, including measures to help boost productivity,
thereby increasing ‘real wage’ growth.
When it comes to defined benefit (DB) plans, respondents reported that what attracts and
retains this group is that they are seen as a good thing, although some low earners may
regard DB contribution rates as an unaffordable luxury.
Among older and higher earners, tax relief is seen as driving higher contribution rates. As
one respondent notes: “Senior and high-paid employees are highly aware and motivated
by the current system”, although another responded notes: “but only if they earn less that
£110,000”.
Other ways of incentivising people to save for their retirement, identified by our reward
professionals, include: education and communication; the importance of the employer
match; and the recent pension freedom and choice reforms, as one respondent says: “The
lack of requirement to get an annuity has had some small impact”. However, respondents
highlight the crucial role that providers and the Government have in supporting pension
awareness through workplace financial information, advice and guidance.
With regard to communication, employers stress the importance of framing when talking
about retirement saving to staff and that, by not joining the pension scheme, they are
missing out on ‘free money’, especially in those organisations where the employer’s
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contribution is higher than the employee’s. Framing can help encourage employees to
increase their contributions.
Members also hope that both the new flat-rate state pension and the state pension
statement service will encourage employees to think about the best way to save for their
old age.
2. Do respondents believe that a simpler system is likely to result in greater
engagement with pension saving? If so, how could the system be simplified
to strengthen the incentive for individuals to save into a pension?
It rather depends what is meant by ‘simple’. Most reward professionals that the CIPD has
surveyed do not think that now is time for TEE. Most believe that it will put many
employees in low and moderately paid occupations off from saving as they would have to
find the money out of their post-tax, rather than their pre-tax, income.
As one respondent noted:
“Many employees claim not to be able to afford to pay pension contributions.
Through our salary exchange scheme, we can demonstrate to them that their
contribution level can be quite low and so their take home pay is not greatly
reduced. If employees don't get their tax relief NOW, they may be dissuaded
from making contributions”.
Others pointed out the impact on employers. For instance:
“This would have serious consequence for us as an employer as the cost would
be prohibitive to continue the current level of contribution we are making (10% of
the basic salary)...”
If employers cut their DC contributions, then this will reduce the incentive for employees to
save through a workplace scheme.
Another concern is because employees tend to discount the value of future rewards, it can
be hard to help them appreciate the importance of saving for retirement. As a respondent
notes:
“It’s difficult for people to feel the value of having a degree of untaxed income in
the future verses the tangible effect of saving via tax and NI concessions at the
moment. I feel such a proposal will cause people to save less for their
retirement”.
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Those workers who were targeting a certain level of contribution will have to save more
under TEE, as has been suggested:
“Employees who realise they will have to pay more to get the same sized
retirement pot will find themselves paying proportionately more tax for their
pains”.
However, others may be put-off due to the additional cost.
There is also an element of distrust that the pension rules will change yet again, and that
employees could find their pension income subsequently being taxed.
“I think some employees may not trust a future government not to start taxing
retirement income, even though their contributions were taxed,” one employer
has noted.
It has also been pointed out that, for some employees, there is:
“The risk is that that you pay tax on something that you’ll never live to enjoy”.
If there is no cost benefit for the employer, it has been suggested that some would just
contribute the minimum legally required and offer salary instead of a higher pension
contribution as the cost would now be the same. Some thought that if there is to be no
difference between a pension and an ISA, then employers will wonder why they are being
forced to offer a pension when an ISA would do, especially as the ISA could be more
attractive for some groups of employees.
The only way to encourage employees to lock away their savings for the long term would
be to offer some sort of financial inducement for doing so, in addition to the promise that
income earned in retirement would be tax free. However, behavioural science indicates
that the size of the inducement would have to be significant to get over the myopia bias of
valuing the current more than the future. To encourage workers not to reduce the level of
their pension savings, the ‘T’ element of TEE would not be truly ‘T’, so adding to the
complexity. Members also wonder whether the size of the tax incentive or rebate would
vary over time due to government interference.
Some are concerned that, under this proposal, the employers would have to contribute
even more towards their DB recovery plans, which would lead them to look for cost
savings elsewhere, as well as cutting back on business-related investment. As one
respondent points out:
“The changes could lead to some employers reducing their DC contributions
and would impact DB recovery plans”.
Others point out that in the public sector, many DB schemes are PAYG. If public sector
worker contributions fell due to the introduction of TEE, then the government would need
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to make up the shortfall to fund current pensions in payment, thus increasing its
expenditure. While it would be getting more money from the private sector due to TEE, this
could increase the feelings (rightly or wrongly) that private sector tax payers are
subsidising the retirement plans of public sector staff.
Some members believe that tax relief on pension contributions is not actually an incentive
to save, but is just a deferral of tax on what would have been paid and the tax on that
income should only be paid when an employee is drawing on it. This means that while this
arrangement reduces the tax take for the current Government, it does increase the tax
take for future governments. However, members recognise that this Government needs
revenue now, especially for unforeseen incidents, and so there will need to be limits to
how much should be exempted. This means that for some with DC pots the size of EET
can differ, for example, ‘little E’, ‘big E’ and ‘little T’.
The difference between how much an individual ‘saves’ on their contributions and,
ultimately, pays out in tax will depend on their earnings profile and tax policy of successive
governments during that employee’s working and post working life. In addition, given the
increase in the cost of annuities, many employees will not have had a big enough pension
pot to buy an annuity that would have put them into the additional tax rate bracket. While
the end of the requirement to buy an annuity could push employees into higher tax
brackets, depending how much money they drawdown from their fund, it could also mean
that they would run out of money before they die and, therefore, fall back on the state.
Similarly, no longer being taxed on their pension could result in employees drawing down
on their pension pots faster and so running out of money sooner.
While there is scepticism amongst our members that TEE will encourage an increase in
pension saving, that is nothing compared to the horror they feel at, what they regard, as
the increased complexity that this approach will cause. Examples of comments on this
increased complexity include:
“I fail to see how a change to TEE, which will take decades to flow through as
past contributions will still have to be treated on the current ETT basis, will do
anything except further complicate pensions”.
“I’m not sure how easy it would be for HR and payroll systems to move from
EET to TEE. I’m not sure how easy it would be to work out which part of an
employee’s retirement income was subject to EET and which to TEE”.
“How on earth are pensions providers going to manage contributions made tax
free and contributions that have been taxed? My understanding is that the
contributions that were tax free will have to be ring-fenced, and a separate pot
will have to be created for contributions that are taxed. And how will pension
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income from a pot that is made up of both tax free and taxed contributions be
treated when it is paid out? Sounds like an administrative nightmare!”
While one can’t make accurate forecasts yet regarding the extra administrative costs
arising from TEE, the CIPD believes that they would be substantial.
In addition, it has been noted that TEE ‘isn’t British’:
“TEE is more appropriate in countries where there is a higher social security
safety net. If we move to TEE, will the government change its approach and
increase the size of the state pension to compensate for the shift from EET?”
Perhaps somewhat cynically, some of our members have questioned whether TEE would
be less about encouraging more employees to save more money for their retirement, and
more about the Government trying to bolster its finances.
3. Would an alternative system allow individuals to take greater personal
responsibility for saving an adequate amount for retirement, particularly in
the context of the shift to defined contribution pensions?
While the member opinions regarding TEE ranges from it not being “...a good idea” to it
being a “ridiculous idea”, they are more supportive of the proposal to have one rate of tax
relief on offer to all employees irrespective of their pay, possibly because of their negative
reaction to TEE. As one member has noticed:
“A standard rate of pension tax relief would reflect the reality of what’s been
going on in the workplace. Over the past 20 years, terms and conditions
between management and employees have been harmonised. If employees and
managers are in the same company pension, why shouldn’t they both get the
same tax relief? The government has already harmonised tax relief on childcare
vouchers, so why not pension contributions?”
However, the importance of communication has been noted as being crucial to the
success of the flat-rate scheme:
“If this was communicated well to lower earners it could potentially lead to more
saving, but the communication is crucial and if done poorly will have little to no
impact”.
An example would be for every £2 you save, the Government will give you another £1.
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Another concern is that, while the tax exempt rate for high-earners would fall, while that for
basic tax payers would rise, what would happen to this new rate over time? As one
respondent puts it:
“How would we know that in the future the tax relief on offer would not fall to the
basic rate? It would start higher, but not remain there for long”.
However, respondents also note that while such an approach could (through proper
education and communication) boost pension savings for low to moderate earners, it could
result in high earners switching their savings from pensions to other savings vehicles, such
as buy-to-let. As has been noted, those employees in a DB scheme who have contributed
to their plan for a long time do not need to be high earners to be caught by the tax
implications from a reduced lifetime allowance. Comments include:
“If high earners save less through a pension, they’ll become less committed to
the notion of pension savings and this could accelerate the rate of DB closure”.
“I am already experiencing negative responses to pensions provision from the
senior team. The IT and process change costs of recent changes (AE and now
the new AA) are distractions from activity and spend in other areas that drive the
business. We provide benefits well in excess of statutory requirement, but there
is a growing view that this results in unrewarded costs to the business”.
“In the LGPS, higher earners already pay a higher percentage of earnings for
the same pension accrual as lower earners who pay a lower percentage. If the
tax free element of savings in the scheme is reduced, it would be unfair to
charge high earners more for the same accrual rate”.
Although some noted that:
“It is unlikely high earners would save less than they would currently do now as
the lifetime allowance is so low” or “Should higher earners choose to reduce
their contribution level, they would lose a matching amount of employer
contribution, so this should discourage this reaction for many.”
However, the main concern with having one rate for pension contribution tax relief isn’t the
adverse impact that this may have on high earners, but the effect that it could have on HR
and payroll admin systems. As one respondent notes:
“This reform would come with an implementation cost and so any change would
need to be introduced such that employers have sufficient time to make system
changes”.
While another has pointed out that to be successful:
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“It would have to be simple for employers to administer otherwise the cost to
them would be problematic, especially in the public and not for profit sectors”.
However, a few are optimistic that while:
“It is likely to complicate administration, this shouldn’t be a barrier to
implementing such a system as the technology should be able to cope”.
While the CIPD is supportive of a flat-rate approach, we believe that we should
wait for automatic enrolment to have been rolled out, minimum contribution levels
increased and recent pension freedoms to bed in, before we look to change the
system again. We would also need stakeholders to be given sufficient time to
changes their systems to minimise change costs.
4. Would an alternative system allow individuals to plan better for how they use
their savings in retirement?
Not necessarily. Our members have stressed that improved financial education and
communication in helping employees plan for their retirement, believing that in the shortterm this would be less disruptive than an alternative system. However, there is some
debate about whether financial literacy should start in the classroom or in the office. It has
been pointed out that learning about pensions at school may be seen as less relevant to
pupils as they saw retirement as a faraway eventuality. Also, it would be difficult for
teachers, many of whom would have little DC experience, to explain how such schemes
worked. As members suggest:
“Start in schools! Make it easier for people to work out what their income might
be worth in retirement through promoting calculator websites and designing
something user friendly... Communicate messages about what an adequate
amount might be and how to get there – e.g. how to work out what saving £X a
week could turn into at what age, etc.”
“I think there is general ignorance of the benefit of pensions and how they work
and it would be really helpful to encourage financial education and a positive
promotion of the investment so that people understand how they can maximise
their contributions. The education system isn't the right place, it is the individual
scheme and what it can offer that needs to be promoted to its members - after
all, you want them to remain in the scheme rather than consider taking their
money elsewhere”.
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“Communication! Through the workplace yes, but not all employers
communicate adequately, and some don't even fully understand it themselves.
Simple messaging and impactful advertising could help, word of mouth I have
found is the most impactful for converting frivolous spenders to saving for a
pension...”
“To part- or full-fund independent advice and encourage all to engage an
advisor”.
“Adopting simple, Swedish-style integrated wealth education and
communication tools, such as the orange envelope? This perhaps shows the
power of affordable (state provided here) joined-up financial data and planning
for all”.
However, as was noted by one employer:
“Financial education is vital, but it can only ever be part of the solution”.
So, while financial education is important, it is only going to fully work as part of an
integrated financial wellbeing strategy, including such as aspects as a living wage and
other risk benefits.
Other suggestions include:
“Stability in pension rules and not making (seemingly) bi-annual changes to the
rules. A watertight compact with citizens (and therefore employers) that it is
worth them saving for retirement and that this and future Governments won’t
change the rules in the next 10/20/30 years before retirement”.
“Spreading the tax benefits of pension saving more equitably throughout the
workforce”.
“Progressively increasing the minimum contribution levels..”, “Make it
compulsory for individuals to start making contributions to a pension as soon as
they begin work”, and “Remove the opt out”.
5. Should the government consider differential treatment for defined benefit and
defined contribution pensions? If so, how should each be treated?
Most respondents thought that it should not.
Among those, however, who thought otherwise:
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“The lifetime allowance arrangement no longer reflects the value of retirement
benefits available from the two types of scheme. It is possible to keep the same
lifetime allowance for both but you would need to amend the DB factor to reflect
current annuity terms”.
“Currently the tax treatment of DB pensions is considerably more generous than
that offered to DC pensions, given that DB pensions have almost completely
gone from the private sector, this increases the pensions’ inequality between
state and private sector pensions”.
6. What administrative barriers exist to reforming the system of pensions tax,
particularly in the context of automatic enrolment? How could these best be
overcome?
The barriers that have been highlighted by our sample include:
“HR and payroll systems would need significant lead-in times to update their
software and programmes. HR departments would need time to communicate
with, and explain the changes to, their finance departments, incorporate into
budgets and communicate with employees. Ideally, pensions’ advice should be
provided as anything that makes pension investments more or less tax efficient
might alter how people choose to invest any free income”.
“The more complex the contribution calculation, the more barriers will appear for
payroll departments. At the moment, our software can't cope with anything more
complex than a percentage of specified pay, auto-escalation would be very
difficult to handle. There is a massive variation in the quality and provision in
payroll software and the industry would need to step up. HMRC would need to
up their game too, RTI still doesn't feel like it has bedded down yet on their
side”.
“We spend an extra two days per month on payroll/pension processing since AE
was introduced and in addition we also have the cost of the additional pension
contributions”.
“Payroll / HR systems are expensive, and not always compatible with 'quirks' of
pension systems... Also, HR / Payroll staff are not financial advisors, and often
end up with a list of questions that they cannot (logistically or legally answer).
Advice costs money”.
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“The problem is that most firms don’t regard HR and payroll systems as a
priority for investment. As a consequence, the only way they can comply with
changing legislation is by spending money in a knee-jerk, ad-hoc, fashion. Until
this mind-set changes, reform is always going to be hamstrung”.
Others were more sceptical about the scale of the administrative barriers, comments
included:
“None, really ... it's just coding software, bread and butter work for system
providers”. “Whilst changes would be required, payroll-system providers are
used to dealing with annual changes to taxation and therefore this would not be
an issue”. “…The administration isn't the issue, the challenge is getting the
solution right and then sticking with it for a generation or more”.
To summarise, the main barriers identified are the costs associated with changing over to
a new reformed system and dealing with the member and employee queries that arise
because of these changes. One way of reducing the barrier is to give the payroll and HR
departments and their providers and advisors plenty of time to amend their existing
systems. A rapid change will only increase changeover costs. Once the new solution has
been created, politicians should try and restrain themselves from tinkering with it further.
Also, change will generate employee queries. To reduce the number, the Government
must have a well-funded communications strategy in place to explain to workers what is
changing, why and how it could affect them.
7. How should employer pension contributions be treated under any reform of
pensions tax relief?
Respondents feel that employer pension contributions should be treated as they are now.
There are concerns that changing the tax treatment would add extra costs to employers
seeking to make good their DB deficit recovery plan.
If the tax treatment for DC contributions were changed, then employers may become
reluctant to provide more than the minimum required and may be tempted to put their
focus on pay and other savings vehicles, which may not support long-term saving in the
UK.
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8. How can the government make sure that any reform of pensions tax relief is
sustainable for the future?
Sustainability depends on the economy. Both employees and employers will be able to
contribute more to their pension schemes if the country is able to move to a high-wage and
high-productivity economy. Government policy should focus on helping employers and
employees improving working practices and then sharing the proceeds generated from
increased productivity through pay and benefits. The ability of the UK to increase its
productivity in the future may be hampered if pension funds have less money to invest in
British firms and infrastructure projects because TEE has reduced the amount of money
flowing into them.
Survey feedback stressed the importance of politicians not changing the pension rules.
There is a growing belief among our members that given the long-term nature of pensions’
policy, it should be taken out of the political arena and given to an independent
commission. Though there is a concern that any such commission must be representative
of all stakeholders, rather than “the usual pension suspects”, and that its decisions must
be evidence-based.
A recent online poll of 800 CIPD members has found that almost three-fifths (58%) think
that the Government should leave the existing pension tax relief system as it is. As one
respondents has commented, the Government needs:
“...to let the current system settle. We have had change after change as
successive Budgets have tinkered with the tax relief position, pension freedoms,
etc. Continual change simply confuses people and costs employers and
providers”.
While another has indicated:
“The current system incentivises higher earners (and the higher rate is now at a
moderate level) to save for retirement whilst AE is getting lower earners into
saving. Salary exchange also makes investing in the market seem "safer" as we
tell our staff that even when the market drops they haven't lost "their"
contribution until the value of ours and the NI saving has been eroded first so
the "free money" has given some reassurance to a number of people”.
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However, if the real objective behind this consultation is to explore ways of saving money
(though how much isn’t made clear) on pension tax relief, rather than strengthening the
incentive to save, then members suggest the following. Reducing:

the relief that additional-rate tax-payers can claim

the size of the annual allowance to UK average earnings

the size of the tax-free element of pension in payment

reducing the lifetime allowance indexation

having one overall limit for all tax-advantaged savings
In summary, the CIPD recommends:

that the existing pension tax-system should be left as it is

an independent commission should be established to make workplace pension policy:
and

if the tax system must change:
o then we should have one tax relief for all employees rather than TEE, which
would reduce employee and employer contributions and be complex to
administer
o we would prefer the annual allowance being brought in line with average
earnings (defined as either the mean, or the median, figure from the ONS’s
annual survey of hours and earnings), if the lifetime allowance could be
scrapped.
o the amount of pension that is paid tax-free could be limited
o employers, providers and advisors have to be given at least two years to amend
their systems in advance of the new system
CIPD September 2015
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