|Pension reform can feel this way|
The chancellor may have gained a reputation for sound economic and fiscal management, but he is also prone to over-complexity.
Where Nigel Lawson once cut the Gordian knot in the 1980s, the elegant simplicity of his tax reforms have since been undermined.
One important component - and indeed one much in the news of late - is that of pensions. Everyone hates the current tangled, incomprehensible system. Currently on the table we see Osborne’s ‘pension ISA’ and a flat rate system.
I propose something different, something both simple and robust. Significantly, it breaks out of the ‘EET’ vs ‘TEE’ paradigm that currently constrains thinking.
The nub of it does see ISAs and pensions merged. Crucially, though, there is a build-in mechanism to discourage withdrawals before retirement. What’s more, the system is relatively easy to administer. So how does it work?
• Each citizen is issued by the government with a ISA/Pension/401k account wrapper (possibly based on their NS number).
• As with ISAs, the account is transferrable between Financial Service providers and can contain multiple asset types.
• Any money an individual adds to their account is first subject to income tax, but then gets a flat rate tax rebate (as per pension reform being currently touted).
• Any money withdrawn before the individual reaches official retirement age is taxed at source by the provider at the same flat rate. After retirement, like an ISA, withdrawals would not be subject to tax.
• Annual limits are high (like £40,000?), as would be the maximum account balance (£1m to £2m?).
I regard this as elegant because it’s flexible and easy to understand. Citizens just have to think like this:
• If I contribute anything, the government tops it up by x%
• If I withdraw anything before retirement, the government knocks off their initial contribution ‘on the way out'
There is thus an in-built incentive to try to keep the money in the account until old age, but at the same time there is no actual penalty for withdrawing the cash earlier if you need it (compared to an ISA). Bingo! People gain the flexibility they want and the government doesn’t do too badly either. If push came to shove, withdrawals after retirement could also be made subject to income tax.
Of course, it’s not quite that simple. Issues remain. What about DB schemes? What if the flat tax rate changes? Should the annual limit be the same for all ages? How do you encourage companies to top up their staff pensions? What happens on death?
Though obviously important, none of these issues are insurmountable. Solutions (or at least partial solutions) to most of these questions have already occurred to me, but I won’t bore you with the more details here. I would prefer to concentrate your minds on the central feature above and welcome any feedback. Is there something in this or is it fatally flawed?