Thursday, 25 January 2018

Fun with numbers: Tax breaks for pensions vs UK annual deficit

From City AM:

Figures published today by HM Revenue & Customs (HMRC) showed the cost of tax relief on pension contributions rose by £950m over the last year to £41bn.

Other tax breaks on pension saving take the total cost to £55bn, Webb said, a figure the Treasury will be studying "with great interest".

OK, here's another figure that the Treasury ought to be studying "with great interest", from The Telegraph*:

Borrowing in the 2017/18 financial year to date is now running at £50bn, down from £56.7bn at the same stage in 2016/17 and the lowest to-date total since 2007.

The figure means Mr Hammond is on course to meet the target set by the Office for Budget Responsibility, the country’s fiscal watchdog, of borrowing £49.9bn in the 12 months to the end of March 2018 - equivalent to 2.4pc of gross domestic product.

I know that it's not big and not clever to compare random items of taxation and spending; or to match the total deficit with individual items of spending (or tax breaks, or subsidies), but it puts it in perspective. We could, in theory, more or less eliminate the current annual deficit by getting rid of tax breaks for pensions (more accurately, people with spare income, more accurately than that, higher earners, and even more accurately than that, subsidies for the lads in The City who soak it all up in fees, charges and commissions).

Broadest shoulders, and all that?
* Particularly sick-making is that the article makes great play of this factoid:

Public sector borrowing in December dropped by £2.5bn, much more than had been expected, thanks to a £1.2bn credit from the EU. It was the smallest December borrowing figure since 2000.

As if this £1.2 bn were a) some sort of triumph by the UK government and not just a drop in the ocean compared to b) UK deficits/spending or c) the massive overall drain that the EU is/will be or d) a completely made-up number.


Rational Anarchist said...

If you eliminate tax credit on pension savings then you'll also eliminate a lot of pension savings. This won't be a problem right away but punting down the road a few years isn't great. Also, any remaining pension investment would then result in an untaxed income in retirement (unless you want to double tax it) which is another problem in a few years.

Lola said...

The EU credit. So we send them £XBn that we have borrowed and they send us back £1.2Bn. What defeats me is why this looney tunes logic escapes anyone.

On the Pension tax breaks, broadly yes.
The bulk of pensions tax relief goes to higher rate taxpayers, and we can ignore all 'tax relief' on public sector pensions (see logic query above). And a whole lot did go to the 'lads in the city' aka sleepy insurance companies aka investment trusts with a hobby, but that is arguably no longer strictly the case. At least not as far as simple pension savings schemes go where typical total expense charges are now 1% at maximum and more like 0.25% on average or lower. Of that 1% fee (or lower) you must remember that 45% goes out in tax (tax freedom day being early June) and something in the region of 18% goes out in 'compliance' costs. A total of 63% ish. Get rid of compliance and reduce taxes and competition will drive pension fund manager charges even lower.
And also don't forget that pensions (as an annuity) are paid as income, you are taxed on the whole payment, unlike purchased life annuities where the only the interest element is taxed. Pensions are deferred pay. Has that been added back in the sums above?

However, in the great scheme of things it is true that all subsidies return to rents. In which case I would scrap all higher rate relief on pensions contributions. And I'd stop all the nonsenses of the The Pensions Regulator (utterly useless) and the levy they take from solvent schemes to prop up insolvent ones (or those considered 'insolvent' under their daft rules).

Mark Wadsworth said...

RA, why do you think people would stop saving? Do you have the slightest evidence for that? People put money into ISAs!

Future problems are future problems.

Mark Wadsworth said...

L, maybe. I glossed over the tax paid by all the middlemen.

ontheotherhand said...

If they got rid of pension tax breaks, would that not just bring forward future tax income? i.e. another mechanism for spending today and storing up a problem of less projected income tax for the future? I'm not saying that the 'lads in The City' would be worse off either way, it's just that the future income tax on their pension streams would be missing if they had no reason to save in pensions? Is my maths off? On 100K gross earnings taxed at 40%, put 60K in a pension and get the basic rate 20K added back, compound it at 5% for 20 years, and then tax the income from the annuity at 40% OR Tax 40% up front, meaning 60k compounding for 20 years at 5%, and then tax the lesser income from the annuity at 40%. The only way this is better for the high earner over their lifetime (so worse for Inland Revenue and society) is if income that would have been taxed at 40% today is part of a tax free allowance and 20% tax rate in the future. Assuming that any high earner will do enough planning to ensure that they have a basic income to retire on in future, any excess income saved away and not consumed today will always be taxed at the higher rate in future as well?

Mark Wadsworth said...

RA and OTOH, income tax on pensions in payment is £10 bn it so a year, which will dwindle to nothing over the next couple of decades. Chump change in the scheme of things.

Lola said...

MW Why will tax collected on pension payments dwindle.

BTW I am not all defending 'high charges' aka rents from subsidies. Some of us have been railing about this for years from within and outfits like Fitzrovia helped a lot by exposing the full costs of funds.

As to people saving if there is no tax relief. Of course they will. Of course the best way to encourage saving for retirement is to scrap the welfare state...

Mark Wadsworth said...

L, pensions are only taxed because people got relief on contributions.

In the absence of this pensions nonsense, people would save with ISAs, no tax relief on way in and no tax on withdrawals, although the investment income and gains are exempt. If there were no ISAs either, then people would just save, full stop, but again, no tax on way out.

if anybody were stupid enough to continue paying into an official pension with no tax relief, then would have to be treated like ISAs or normal savings.

It is only pensions deriving from "old" contributions that would be taxed on the way out, so tax collected from "pensions" in the narrow sense would fall every year as the "old' pensions cease when people die.

Lola said...

MW ah you meant once pensions have been scrapped. Then, of course.
Personally I'd scrap ISAs as well. And VCTs and EISs and all these opportunities for rent seeking.

paulc156 said...

Good post this MW.

Lola, the .25% management charges you refer to is perhaps a joke? A year long study completed in 2016 by the Transparency Task Force found over a hundred charges levied by asset managers, many of them hidden. Charges easily capable of swallowing up the lions share of the pension pot over a period of thirty odd years or so. In fact the real cost of these charges is several times the headline 'management' cost.

Lola said...

P156. Without any doubt pension funds are available with total expense ratio charges at 0.25% and lower. The TER figures take into account all those hidden charges (which were not actually ever hidden as such, just not included in the illustration methodology prescribed by the regulationists). As I said above this transparency agenda was pioneered by Fitzrovia among others many years ago. I was using their data in the late '80's early 90's. In fact today we can buy institutionally priced funds for clients which have nil initial charges and 0.15% TER / OCR. And with stock lending fees which all equitable managers credit to the fund, some fund managers now think that they will be offering positive TER's.
The Transparency Task Force is just another FCA prodnosery justification committee. The market has already dealt with issue in general over many years, not just one. FYI the TER is about 40% greater than the declared AMC. You should note that the AMC is the fee to the manager for managing the fund. The other expenses include other costs chargeable to the fund like custodian fees, audit costs, stamp duty and the like.
For high charges you need to be looking at EIS and VCT's or hedge funds with their standard 2 and 20 pricing (as was).
In regards to the Regulator the FCA etc , they are absolutely useless and functionally corrupt. It's the incentives see. None of them have any democratic legal or financial accountability and no skin on the game.

paulc156 said...

...and I didn't even mention churning. Until January this year fund managers have not been required to explain how much of investors’ money (workplace pensions) they’ve spent on transactions. Forced, mind you. And charges buried in small print are effectively hidden charges.
Andy Haldane, the Bank of England’s chief economist: “I consider myself moderately financially literate – yet I confess to not being able to make the remotest sense of pensions.Conversations with countless experts and independent financial advisers have confirmed for me only one thing – that they have no clue either.”

Lola said...

P156. Haldane is a clown. The nonsense he is talking about is entirely the fault of clowns like him who have massively over-complicated pensions regulations. It has nothing to do with the underlying investments - it's the looney tunes rules. But he is sort of right about one thing, the rules - rules made by the likes of him - are so ludicrously complex that they are difficult to keep on top of. And then there's what the HMRC comes up with.

As to 'churning' it is not at all as rife as is made out. In any event low cost funds - of which there are lots - by definition cannot be adding costs. Furthermore churning of the underlying investments does not make money for the manager. It makes money for the broker.

Like all things you buy you have to do your shopping and you will find relative value for money. WE can argue the toss as to whether using a collective is worth the fees or not, but the fact is - and I can prove this - there are low cost efficient collectives out there that have delivered a fair return for the =ir buyers at low relative risk. Sure you can go and buy your own shares and make your own 'fund' but it is a practical impossibility for you to access, say, smaller companies stock at the price I can and with the degree of diversification I can.

One thing I do know is that 'active' management in the traditional sense does not overall add any extra return over the market rate of return. Most add no alpha over the beta of the market. And they cost more. Very few active managers are worth buying - and I mean very very very few. Perhaps five - and I can't reliably find out who they might be.

Mark Wadsworth said...

L, OK, let's accept that saintly pension fund managers restrict themselves to a 0.25% or 0.5% cut every year, what do they invest in? Unit trusts and investment trusts, which swipe another 1%, all of these pension schemes and unit trusts need "legal and professional" advice, statutory audits, tax returns, Pensions Regulator returns and reports, with some lads in the City earning themselves silly.

Lola said...

MW No! The 0.25% / 0.5% is the TOTAL charge. The TERs include all the stuff you mention.

paulc156 said...

L.You are deluding yourself. Funds can charge as little as that. Most do not. Like I said only this month pension funds have been forced to reveal their transaction costs which are in in addition to the fees levied. And frankly whether Haldane is a clown or not (whatever that means) if the chief economist at the bank of England can't bloody understand the crap info pension funds put out who the heck else is expected to?
Nor does it matter that brokers not pension fund managers benefit from excessive trading. The point is pensioners are only profiting at all from pensions largely BECAUSE of the taxpayer subsidising of city spivs! Without such subsidies returns would be trivial.

Lola said...
This comment has been removed by the author.
Lola said...

P156. FFS P156 this is my business. I have spent over 25 years finding ways to reduce prices for my customers, which is largely why I am not as rich as most of my peer group. The 'hidden' costs in funds have been known about and calculated for years. And I have acted on that information.

The recent regulatory intervention is way behind the curve and actually is more about deep state data collection than helping customers.

To stop this argument I will in due course assemble the information and write a post on this blog to prove it - with all the links and attachments and everything. (That won't be soon, I am very busy at work and Mrs L has pneumonia and is hospitalised).

Please note, that I am one of only small number of people in my trade who are as determined to reduce prices. Fat lot of good it does me though. I recently lost a client to St James Place - and you should see their charges - generally 5% initial (we are 0%) and up to about 2.0% annual (on a like for like basis we are about 0.9% annual - that includes some 'advice' charges). Those annual numbers are 'Total Expense Ratios', that is they include for everything, all of it, the lot, tutti, not just the AMC.

Re the rest of your post you are not listening. Haldane was not railing about the underlying funds, he was railing about the bureaucratic rules around pensions - which are the fault of him and his ilk. Get it through you bonce that there are two things going on (1) the looney tunes pensions rules and (2) the underlying investment funds.

And you know I quite agree that 'all subsidies return to rents' and that a lot of the tax relief ends up in the hands of the pension managers (or especially cash ISA providers) and I have been trying, professionally, to minimise that effect for my customers for 25+ years. I can tell you more horror stories than you can imagine (the St James Place one above is just one of many). But for an absolute fact I can get you a fund / funds plus the pension administration wrapper for about 0.35% / 0.40% all in, everything, varying a bit with quantum.

Stop trying to tell me about my business which I know inside out.

Lola said...

P156 et al. In fact I have been in this trade nearer 30 years now...

paulc156 said...

L. Not questioning your own high standards. Just your industry's standards.

Gina Miller (the same one who took the government to court over parliament vote on Brexit) was on radio 4 last week saying much the same as you.Her investment management business has lost out to competitors who prefer to keep charges and costs opaque since she reformed her own businesses approach. As for the costs and degree of opaqueness it's no use just pulling rank. Here's what actually happened to rail pen.
"Railpen's director for trustee accounting Victoria Bell says the costs,(which thry were unable to identify) included commissions, brokerage fees, stamp duty, due diligence fees and legal fees. Pension fund accounts for 2011 showed total costs of £90m, but the forensic search uncovered an extra £200m, some of it from layers of fees charged by funds investing in other funds."

They had to hire a forensic accountant to find that out!
You might want to give last week's radio four podcast on this subject a listen. I hope your wife has a speedy recovery.

Bayard said...

"If you eliminate tax credit on pension savings then you'll also eliminate a lot of pension savings."

Despite knowing very little about pensions, (perhaps Lola can help here), I would have thought that the people most likely not to stop saving are also the people benefiting the most from the tax breaks, i.e. those paying more than the basic rate of tax. Thus the obvious first step would be to limit the tax break to the basic rate and see what happens, although there's fat chance of the Tories doing that.

Lola said...

P156. Nowhere have i claimed that there are parts of the FS industry thst are less than transparent. I have been saying that you can (a) quite easily find out tge 'hidden' costs of fund management and (b) you csn buy low cost funds.
In your example you stress it needed a forensic accountant to find these hidden charges. Well i am not one of those and i found them. And since they were findable they really weren't that hidden.
To make another observation from my own experience regulationism has aggravated the whole hidden charges (and costs generally ) issue.
Gina Miller is not reliable. Why has it taken ubtil now to do something i and my peer group have been doing for 25 plus years?
Thanks for your concern re Mrs L.

Mark Wadsworth said...

L, if there are pension funds with a TER of only 0.25% including all the endless layers of crap, then I am quite impressed. That seems fair enough.

Lola said...

MW. See my new blog post above.

Mark Wadsworth said...

L, thanks, splendid.

Do you think you could break up the long paragraphs a bit? It's hard to read.

Lola said...

MW Nowhere near as hard to read as the literally millions of paragraphs in the pensions and FS regulations...:-)