Taxation - Choosing between pensions and ISAs

One of the delights of my job is to be able to plough through the, says Nigel Eastaway. Inland Revenue’s consultative documents on matters such as the taxation of life insurance policies (since abandoned), pension schemes (now responded to) and now individual savings accounts. Perhaps the time has come for a review of the whole savings arena in order to determine what we should be trying to encourage, and how to do it.

It must be obvious that, with an ageing population, the workforce in work will eventually be unable to provide sufficient taxation to pay for pensions, benefits and care at the level we have become accustomed to, far less improving these benefits.

Many employers are moving from final salary pension schemes to group personal pension plans, or other money purchase schemes, to contain the costs of pension provisions.

If we accept that any government is going to be strapped for cash to provide for the benefits and care currently available, any reorganisation of savings taxation must not reduce the overall tax yield from this sector of the economy, and it is therefore important to make sure those reliefs that are available are actually used to encourage the sort of savings which the government would like to see in place.

Encouraging pensions

Most people will need a pension in their old age and the tax system encourages this by giving relief on contributions into a pension scheme and allowing a fund to be built up free of tax. The tax charge is merely deferred because the pension, once payment has commenced, is itself taxable.

This does not seem an unreasonable means of encouraging pension provision, but it is difficult to see where a tax-free lump sum fits into the scheme.

The disadvantage of a pension arrangement of this nature is that it requires premiums to be paid throughout an individual’s working life, if a reasonably worthwhile pension is to be provided for. Most people, if left to their own devices, would not make sufficient provision to fund a reasonable pension.

This raises the question of whether there should be a requirement to make a minimum contribution, and if so, how this can be enforced.

Employees could have a superannuation deduction in respect of every pay-cheque, which has to be paid over to an approved pension fund. For the self-employed it might be possible to collect pension subscriptions through the tax system in the same way as Class IV national insurance is currently collected. This would be made easier if tax under self-assessment was collected monthly instead of half-yearly, and the amounts so deducted would be paid into a personal pension scheme for the individual.

There are problems with the unemployed, and those with an income below taxable limits, and it would be necessary when looking at unemployment benefits and income support to include a payment on account of future pension provision to personal pension funds.

People will also want to save, if at all possible, to supplement that which is locked up within a pension scheme. This is where the TESSA, PEP and ISA come into play, and there is a strong argument for encouraging savings within such a tax-exempt fund.

The rules that have applied to TESSAs and PEPs, and are proposed for ISAs, are highly prescriptive and it is difficult to see the necessity for anything other than a properly regulated fund manager, able to offer savers a variety of savings-related products.

There seems no reason why an ISA should qualify for a payable tax credit when a pension fund does not, and the money saved could be used to increase the annual limit. It might also enable accumulative maximum contribution to be avoided, which seems to go against the theory of encouraging savings throughout life.

We should be seeking a system of taxation to encourage investment and saving which encompasses investment accounts, pension funds, insurance policies, unit trusts, investment trusts, direct investment and home ownership, within a coherent and consistent scheme, to use the income tax and capital tax reliefs to the greatest advantage in achieving self-sufficiency where the state can no longer be relied upon to provide more than the barest minimum.

Nigel Eastaway is chairman of the technical committee of the Chartered Institute of Taxation and a partner in Moores Rowland.