On the futility of tax breaks for pension schemes

I know I've posted on this before, but I had to write an article on this today (I'll tell you if and when it's published) and so here are the up-to-date figures:

1. HMRC's Table 1.5 gives the net figure after deducting income tax withheld from pensions in payment as £18.9 billion and the PPI's Pension Facts Table 29 gives us the figure for income tax deducted from pensions in payment as £8.4 billion, so total income tax relief gross is £27.3 billion.

2. HMRC's Table 1.5 also gives us the value of National Insurance (NI) contracted out rebates as £9.3 billion and NI relief for employer contributions as £8.2 billion. The figure for NI relief for employee's contributions must be about 12/13.8 x £8.2 billion = £7.1 billion, so total NI relief is £24.6 billion.

3. You could argue that the £8.4 billion tax on pensions in payment (i.e. annuities) should be deducted, but in the absence of pension scheme tax breaks, income tax would only be applied to the interest element, so in today's low interest environment, it would be negligible.

4. ONS Pension Trends, Chapter 8, Figure 8.12 tells us that total contributions to funded pension schemes are about £86 billion a year. Assuming that's the net cash contributions and the £51.9 billion income tax/NI reliefs are on top, the average value of the tax relief is 38%.

5. If we work backwards from the £8.4 billion income tax deducted at an average rate of 20% from annuities, total annuities being paid out are £42 billion.

6. So that's £137.9 billion going in every year and £42 billion coming out, leaving us a missing figure of £95.9 billion - this must either be going into higher pension funds values (it isn't - see 8); being lost on the Stock Exchange (probable) or being soaked up in fees, charges, commissions and other profits of the pensions "industry" (definitely).

7. There is - unsurprisingly - no official figure for the total fees and charges of the pensions "industry". The Daily Mail quoted a shock-horror report saying that total fees were £67 billion a year, which seems on the high side, so let's round that down to £50 billion a year (2.5% per annum on assets under management of about £2,000 billion). A report by Consumer Focus (see page 12) said that fees and charges reduced the final value of private pension schemes by 40%, i.e the entire average 38% value of the tax relief was soaked up in full by the providers.

8. So that leaves us net cash inflows to pension schemes of £45.9 billion a year.

PPI's table 28 tells us that the total value of assets (mainly quoted shares) in pension funds went up from £1,560 billion in 2003 to £2,120 billion in 2010. Simply investing £1,560 in the FTSE 100 back at its low point in 2003 and reinvesting dividends (assume 4% yield) for seven years would have built up a fund of £2,052; the FTSE 100 index went up by (say) 20% so that's £312 capital gain; and had you invested another £45.90 every year for seven years you'd have contributed another £321, so a very rough and ready calculation says there ought to be +/- £2,685 in your fund now for every £1,560 in 2003.

That expected +/- £2,685 billion is only £2,120, so £565 billion has simply gone missing over seven years, or £81 billion a year over and above the £50 billion fees and commissions mentioned in 7.