In pensions what gets taxed gets done

In pensions what gets taxed gets done.

There is a saying in Professional Services: ‘What gets measured gets done’. In short - be careful what you measure, as you need to be prepared for the consequences.

With the UK pension industry, the very same point is true. We need to be very careful what we do and don’t tax. Where the government gets this right it is a force for good and for change, but when we get things wrong it can have quite the opposite effect.

The UK’s Defined Benefit pension regime used to be very successful. Perhaps the envy of the world, for the saver at least. Pension schemes looked after almost two trillion pounds of UK pensioners’ money, much of which was invested in the UK stock market or government gilts.

It was so successful that when I started my career at PwC in the early 90s, many DB schemes were in a surplus position and taking a contribution holiday. We now know that this surplus was partly a function of very high interest rates which flattered the funding level of the schemes.

The industry was then rocked by an infamous event: in 1997, the government took away the tax credit on dividends received from UK equities. The rationale was that this sector had plenty of money (perhaps that part was correct) and therefore did not need additional tax incentives, which could be applied to other priorities. On the face of it this analysis was logical.

However, a number of things started to move against DB pension schemes. Firstly - interest rates fell, pushing up the discounted value of future liabilities. Secondly, people started living longer, perhaps partly because many had an excellent DB pension helping to look after them!

In the years following this, a number of DB pension schemes started to fail. With lower returns on assets and increasing costs of liabilities, it became inevitable that people could no longer expect the bumper pension they hoped for.

So the Government acted again. But not to encourage more affordable benefits and protect a brilliant UK institution, instead to insist that companies underwrite the cost of buying out their DB schemes with an insurer should the company go bankrupt. Pension trustees were even encouraged to fund schemes to these super prudent levels. What was intended as a policy to protect DB pensions pushed them into a war of attrition - which ended in the only place it could - DB pension schemes became unaffordable for companies and their shareholders.

However it was another tax change that was the death knell of the DB pension scheme - the lifetime cap on a pension pot, and the same issue that has been destructive to our NHS. What gets taxed gets done. By putting a lifetime cap on pension savings, most of the C-suite were no longer benefiting from DB schemes. If you’re not going to benefit from the firm’s DB scheme, and it’s already very expensive, why keep it open?

We have all seen the impact of the combination of these changes: Nearly all UK corporate DB pension schemes have closed, while some of our top NHS consultants found it was no longer attractive to work with the cost of their DB pension benefit breaking through the lifetime allowance. Was the extra tax revenue really worth the knock on impact on the pensions landscape and the NHS?

There is another interesting knock on effect. Encouraged by the pensions regulator, the remaining DB pension schemes were buying huge quantities of government gilts. So although the UK economy was starting to feel the loss of investment in UK equities, at least demand for gilts was strong. Fast-forward to today’s twilight period of the DB era where we find our precious schemes are now encouraged to buy-out with insurance companies. Now those gilt holdings are being sold, and the majority of pensioners’ savings are flowing into international bond portfolios. This is great for the security of the remaining members, but not so great for the UK economy - the days are gone of the UK government offering gilts with almost no or indeed negative return and expecting pension schemes to hoover them up, and gone with them are the years of low interest rates we had all got used to.

We now have a growing DC industry in the UK. It’s smaller than the DB industry used to be and provides benefits at a much reduced level. But at least people are starting to take interest in the space and some Master Trusts are starting to get real traction in the marketplace. There is much talk in the press about encouraging these schemes to invest more in UK private capital - much like our DB pension schemes used to.

I have spent some time looking at our DC pension schemes in the UK and where they invest. In our UK Deals business we have over 2,000 people, many of whom spend their time advising private capital on how to make good investments. The irony of this is that not many of us benefit from the private capital industry in our own pension portfolios - the option to do so simply doesn’t exist in a compelling format.

How do you get more people to save more into their DC pension scheme, at the same time as investing more in the UK economy? Perhaps part of the answer lies in what led to the collapse of our DB industry - how we tax it.

If tax relief is targeted at UK equities and savers are given confidence the cap on pension pots will not be put back in, perhaps money might start moving back into UK equities and private capital.

I was recently on a call with some colleagues in Australia, where they have a very successful DC industry. We were looking for lessons to help the UK. There are lots of things they do that are interesting: You can move between providers easily, you can compare returns easily and importantly they have a catchy name - I think you’ll agree that ‘Supers’ sounds much better than a boring word like ‘pension’.

At the end of the call, the person dropped in a line that made me sit up: “In Australia DC pension schemes have large holdings of Australian equities.” I asked why. My colleague laughed. “Well, we have this interesting rule that gives tax relief to pension schemes on dividends from Australian companies.”

In pensions what gets tax relief gets done…

Victoria Tillbrook Mark Jennings Stephen Soper Katie Lightstone Atul del Tasso-Dhupelia Chris Venables Minesh Rana Anthony Rushworth Rob Hebenton Matthew Smith Mike Holford Lauren Baba Michael Stevens Matt Gilbey Jenny Copeman Christopher Cockerill Simon De Young Tim Hughes Lucy Stapleton Sonam Sumeria Gail Jones Pete Grove Camilla Knox