Wednesday, 19 May 2021

Who benefits from the pensions tax breaks?

Somehow, we drifted off KLNs and started discussing the taxation of/subsidies to pension savings.

Me: "The bulk of the [tax breaks] superficially goes to higher rate taxpayers (who would save up for their old age anyway, with or without 'encouragement') but is actually largely siphoned off by the FS sector."

Lola: "... as I may have said before, you can now buy pension funds with costs capped at about 0.5% p.a. Actually the worse siphoning off of tax subsidies is in cash ISA's."

Agreed to the last bit. For some mad reason, people who can afford to save would rather have 0.6% interest 'tax-free' than 1% gross taxed at 40%. Basic rate taxpayers should really choose 1% gross taxed at 20% rather than 0.6% tax-free, but the numbers are so small, it doesn't really matter in practice.

By analogy, if they scrapped tax breaks for pension savings or ISAs and cut the headline income tax/NIC rates to match, the final outcome wouldn't be much different. The pay-as-you-go state pension is still the best way to go; it's cheap, reliable and effective on whatever measure. And for about a third of actual voters (pensioners are only one-quarter of the adult population, but they have the highest voter turnout), the state pension is pretty much the number one issue - pensioners vote for whichever party makes the most generous promises (it's not their money), and this is one thing in party manifestos that they stick to if they get elected.

To my first point, the total cost/value of tax breaks for pension savings is at least £40 billion a year (trawl HMRC stat's at your leisure). The ONS says that the total value of assets held in pension or annuity funds was £6,100 billion (in March 2018 - it might have gone up or down since then).

Charges of 0.5% seem fair enough, let's round that up to 0.75% for all the extra charges they sneak in - the cheekier ones, the hidden profits they make on paying out stingy annuities, the transfer fees etc. On that basis, the total charges are 0.75% x £6,100 billion = £46 billion.

I rest my case.


Bayard said...

ISAs baffle me. The interest rate on mine is something like 0.2%, so close to zero as to make no difference. So what if it's tax-free? If I didn't already have one from the days before interest rates were a joke, I certainly wouldn't bother opening one. As soon as the plastic £50 notes come out, I think I'll withdraw the lot and bury it in a plastic box in the garden.

mombers said...

The quasi Basic Income for pensioners - state pension + pension tax credit for a minimum income for all - is all that the state should be providing, agreed. Luxury pensions like mine are a strange thing to allocate so much tax expenditure (tax relief) on. The fiddling around with annual allowances, lifetime allowance, etc are after the fact attempts to ameliorate the obscene incomes that many pensioners enjoy, taxed at much lower rates than non-deferred income. One person I know of has a notional pension pot of £6m (SIX MILLION) due to luxury defined benefit pension. Under new rules they'd suffer tax rates of well over 100% if they contributed any further. Limit tax relief to basic rate, lifetime CONTRIBUTION allowance of say £1m would be simpler. Simpler still would be scrap relief altogether and make the state pension higher to enough to support a very modest lifestyle and make it non contributory so you can get rid of pension tax credit, winter fuel allowance, bus passes, etc

Lola said...

MW. My other problem with all this is that my charges, and the pension industry charges, contain lots of tax. F'rinstance. Tax Freedom Day is May / June ~ 45% of all revenue and wages. 'Compliance' costs - both direct and and dead-weight are about 18% of revenue across the FS landscape. That's 63% I charge £1 0 I get 37p the government gets 63p.

My 0.5% figure was for OCR / TER - i.e. all costs. And you do not have to buy an annuity and most people don't.

Lola said...

Mombers. Why do you think 'advisory' outfits like mine have a job? The pension rules are monumentally stupid. A classic of layer upon layer of failed interventions by governments and bureaucrats. The whole lot could easily be simplified.

My suspiscions are that proper reform is being blocked by the civil servants who benefit most from the current situation. My personal view is that along with restricting tax relief to basic rate, all government DB schemes are closed to new members and the benefits for existing members are frozen although indexed and the whole lot of them switched into DC schemes. This would align the incentives of bureaucrats with the success or failure of the economy i.e. the success of failure of the policies they advocate and implement.

Cash ISA's are a scam. Investment ISA's work better as there is not much 'return of subsidies to rents' possible. The real advantage of investment ISA's for large portfolios is ease of admin as there is no CGT to worry about. The underlying investments can be managed solely for investment reasons, not tax reasons. And income from ISA's is tax free. The return on a non ISA'd fund are not significantly less on the same fund that's been ISA'd. Hence the tax breaks add very little actual return. And again, you can access an investment ISA effectively 'free' - that is the costs of doing the ISA are taken out of the 0.5% (say) fund charge.

Mark Wadsworth said...

B, agreed.

M "Simpler still would be scrap relief altogether and make the state pension higher to enough to support a very modest lifestyle and make it non contributory so you can get rid of pension tax credit, winter fuel allowance, bus passes, etc"

Agreed. But the basic state pension of £180 a week seems plenty enough to me. If we got rid of tax breaks for saving, quid pro quo should be cutting taxes on employment, starting with scraping Employer's NIC and mandating a statutory pay rise of 12% on all wages and salaries at the time it is scrapped (to ensure employees are seen to benefit, whether they really do is a separate question).

L, both comments, agreed. Net income of 37% of turnover is par for the course in the UK and most developed countries.

Lola said...

MW. As an employer I'd be delighted if NIC's were scrapped and I was 'required' to give my people the 12% pay increase. As a small business I'd have just done that any way. So why not scrap both employee and employer NICs? That'd give employees a 25.8% pay rise? And that'd prove the lie that 'employers pay towards employees NI'.

Lola said...

Slightly o/t - but when just checking NIC rates I noticed in the side bar the HMRC has two statements - thus:-

Decide what type of employee you need

and, Check you can afford to take on employees a tacit admission that taxing employment reduces employment by making it more costly.

Dear God I despise these people.

Mark Wadsworth said...

L, employee's NIC is just income tax by another name. Worst tax is VAT, followed by Employer's NIC.

L, me too.

Bayard said...

"And that'd prove the lie that 'employers pay towards employees NI'."

What do you mean by 'employers pay towards employees NI'? Do you mean that, if there was no NI, wages would be higher, or that employers' costs would be lower?

Bayard said...

"The fiddling around with annual allowances, lifetime allowance, etc are after the fact attempts to ameliorate the obscene incomes that many pensioners enjoy, "

Having once worked in the civil service, I suspect that the complications in the tax code are there more due a bureaucratic belief that every eventuality, no matter how unlikely, must be covered, otherwise someone is getting away with paying less than their fair share, despite it being a law akin to Parkinson's, that this complexity means that, for every loophole you close, you open two more.

James James said...

If you shop around you can get low fee funds wrapped in low fee ISAs and SIPPs, in which case the tax breaks accrue to you.

It's not the government's fault if people don't make an effort.

Mark Wadsworth said...

B: "Do you mean that, if there was no NI, wages would be higher?"

Clearly they would be.

JJ, yes, but it's a lot of effort. People would make more of an effort it is was their own money.

Mark Wadsworth said...

JJ, actually, the point is, if people are saving for themselves with no tax breaks (and preferably low tax), the sensible thing to do is buy shares directly, not faff about with intermediaries like ISA 'wrappers' and unit trust and pension fund. That's your cheapest option. And would be good for 'shareholder culture/activism'.

Lola said...

Whilst we are on the subject of 'tax breaks aka subsidies, and noting that I am in the business, here follows a list of my real pet hates:-

Help to Buy ISA (especially venemous)
AIM IHT portfolios
Cash ISAs

Any more for any more?

Lola said...

MW. Not if you want real diversification it isn't. The Cheapest option that is. And you really do want diversification.

ISA's using well diversified collective investment schemes can now be accessed for very low money. And they will give you access to the global stock and bond markets at a price the individual investor cannot possibly match.

That global diversification reduces market and specific risk to a level that most ordinary retail investors can tolerate. You have a tiny chance of absolute loss. Whereas holding a few stocks yourself exposes you to a lot of risk of 100% loss.

Very few people are prepared or even can do the work necessary to make sensible common stock buying decisions and no-one I have ever met can do that for bonds - fixed interest securities.

And I can count on the fingers of one hand the number of customers I have met who know what 'capitalism' is or how it works. (Mostly they have been fed the Marxian straw man capitalism propaganda).

So I earn my wage by stopping people doing stupid things, not 'making them money'.

James James said...

"People would make more of an effort it is was their own money." It is their money! Nick Szabo said it best, negative yield bonds are a tax on the senile elderly.

Mark, your info is out of date. Lola is right. Buying individual shares is more expensive because you get hit by multiple dealing charges. Passive funds like Vanguard are very cheap, 0.1-0.2% management charge.

Any dealing platform is going to charge a fee as well, regardless of whether it's a tax-free account or not, so you might as well take the tax-free option. Platform charges are low these days as well, as long as you shop around. Some platforms are fixed fee, so they're even cheaper once you have more than about £200k.

Mark Wadsworth said...

L, JJ, OK, but from what you say, the management charges in competitive non-subsidised funds are lower than with pension funds.

As to diversification, maths and records tell us that if you have at least thirty randomly selected shares, you'll probably get the same overall performance.

Lola said...

MW. Pension funds are the same as any collective these days - mostly. The manager just applies different tax rules without any increase in charges.

That 30 share rule (which L&G were peddling oooo about 25 years ago to my certain knowledge) has been shown to be flawed. Better risk adjusted returns can be obtained by very well diversified mixed funds which use the Fama French insights to take a marker portfolio with tilts to small and value stock.

FWIW our basic portfolios use these insights and use institutionally priced funds. Our 8 fund portfolio (using global stock and FI funds plus property share ETF's) has an OCR of about 0.32% and we've back tested it thoroughly.

But what does seriously worry me is that people who should not do so are being forced out of cash into stock and bond funds in a desperate search for yield by QE and ZIRP etc. This is very very wrong.

Mark Wadsworth said...

L, the "thirty" rule is not specific to shares, it is a general observation from statistics, if you take the average of a random sample of 30 from a larger population, it is usually remarkably close to the average of the whole population.

Clearly, the bigger the sample the better, and ideally measure every subject, but "the first thirty" is close enough.

Lola said...

MW. Yes. I did know that. Like the 80:20 rule.

The point I was making that by using a much larger population - the global capital markets - and then sampling those by the factors that drive returns you can achieve superior return to the '30 stocks returns' at a lower risk. And at a low price.

Mark Wadsworth said...

L, yes, the more the merrier. And a handling charge of less that 0.5% (reducing your dividend yield from 4% to 3.5%, so what?) seems perfectly reasonable to me.

That's all fine, you know infinitely more about this than me. My point was, if in a competitive market, people are happy to pay 0.5% to people providing a valuable service, then great.

I just don't see why lower earners who can't afford to put much into a private pension should be subsidising the 0.5% incurred by high earners who can.

Lola said...

Strictly speaking the smaller savers are not subsidising the bigger savers into private pensions. The exact opposite in fact. For insurers the set costs recovery time is much longer for small savers than big ones.

Just to give you a flavour of what setting up a £100 p.c.m. PP gets us all involved in, regulationism requires us to provide about 110 sheets of A4 (ditto for an investment iSA). And it's no good sending pdf's - they don't get read. Then we still have to make the application, which is now generally and thankfully on-line. Even if you go direct insurers have to do much the same and they would prefer that we did that work, as it saves them costs of a client friendly front office.

What's more I can assert from experience that most people have no clue about pensions and investments. That knowledge has reduced since I started 30+ years ago.

James James said...

I suppose the problem comes about from the principal/agent problem when the employer chooses the pension fund, they don't have as strong an incentive to choose low fees.

Luckily there are some pension funds like Royal London Group which are mutuals and try to minimise their fees (they return the surplus if they overestimate management charges for a year!).

The other factor is that passive investing is better understood than it was 30 years ago, hence the rise of the passive investing sector. People understand now that it's rarely worth paying someone a lot to "beat the market", it's better to focus on low fees and let diversification take care of the performance.

Lola said...

That used to be the case in the days of initial commission on GPP's. The big 'consultancies' like Crapita (allegedly) used to re-broker GPP's or similar every couple of years or so and pay an kick back out of the initial commission received to the directors. I have seen this. (We never did this. We worked to provide the best scheme and generally on a fee basis - hence we won very little group DC pension business...).

Agreed about RL. And there are others.

Agreed - generally - about passive investing. Although passives - as in trackers - have their issues. There are better evidence based managers now that also run low cost funds based on algorithms that screen for the factors that drive returns.