OREANDA-NEWS. Aon Hewitt, the global talent, retirement and health solutions business of Aon plc (NYSE:AON), has rejected ISA-style pensions in its response to the government Green Paper on pension tax.

Aon’s response highlights that an ISA-style system, where pensions are taxed as people save, as opposed to the current system where pensions are taxed when they are drawn, would fail to appeal to savers and employers. It highlights that such a system removes any incentive for employers to support a workplace pension scheme. In addition, Aon believes this model would not allow Government flexibility over future revenue raising as it disconnects raising taxes from the period during which those taxes will be required. Finally, members have expressed a concern that future policymakers may renege on their promise of keeping pension income tax free.

Instead, Aon has proposed an innovative new pension system where pension contributions would be paid from post-tax pay but with an explicit government bonus. This incentive-based approach*  - Incentive, Exempt, Taxed (IET) -means that for each ?2 the member or employer pays into their defined contribution (DC)  pension pot, the Treasury would pay an additional ?1 bonus directly into the member’s pension account. Both employee and employer contributions would qualify uniformly for the Treasury bonus with a maximum pension annual allowance of ?30,000 (?20,000 plus a ?10,000 government bonus).

Aon’s proposals include a five year carry forward to recognise variable earnings patterns, particularly among the self-employed, and to enable those who start pension saving later in their career. The existing lifetime allowance would be scrapped for DC schemes and all people, including those with Lifetime Allowance protections, would be able to pay de minimis contributions of ?2,000 per annum (with a ?1,000 bonus).

Aon’s model aims to recognise and anticipate the financial pressures faced by savers at different points in their lives. It offers early access for young savers, to build on the success of auto-enrolment. It also offers incentives to leave pension savings invested for longer, in recognition of the challenges presented by an ageing society.

Kevin Wesbroom, senior partner at Aon Hewitt, said:

“We believe that simplicity and understanding are critical to encourage individuals to save for retirement. Incentives should be simple for individuals to follow – a bonus is much greater motivation than tax relief. A simple transparent system will also keep future policymakers honest.

“Our proposals recognise the realities we face in relation to pension saving - young people have priorities other than pensions and at the same time longevity will increasingly place financial strain on our pension and healthcare systems. Any redesign of pension taxation should give clear signals of the consequences of longer working lives. We believe it should pay to work and pay to save.

“In our view, employers have a key role in setting out sound long-term savings and investment policies and our proposals ensure that existing incentives remain for employers to continue to support pension saving.”

Aon Hewitt poll results show support from pension professionals
This view is shared by the majority of over 200 pension professionals that attended an Aon webcast on 29 September. Only 8% of the respondents to the poll thought that an ISA-like pension system would be preferable while the vast majority (40%) would go for the Aon model  with 32% of them wishing to retain the current system with some changes.

Additional features
In addition to the features outlined above, the Aon model features three components – a Foundation Phase for younger savers, a Pension Growth Phase and a Distribution Phase when members start thinking of how to use their pension pot, using the 2014 Pensions Freedoms.

Clare Abrahams, DC consultant at Aon Employee Benefits, explained:
“During the Foundation Phase, younger members would be entitled to withdraw their personal contributions (but not the employer’s) from the pension scheme should they require to do so, repaying the linked Treasury bonus. We recognise the challenges in encouraging younger workers to save for retirement as the financial pressures of repaying student loans, purchasing property and other major life events tend to take financial precedence.

“By building on auto-enrolment mechanisms, but offering a window during which young people need not fear their personal savings are locked up for years ahead, we believe we can reduce opt outs from auto-enrolment, and encourage young members to build up pensions savings from an early age.”

Lynda Whitney, partner at Aon Hewitt, continued:
“In the Distribution Phase of our proposals, we aim to encourage people to consider leaving their savings invested for as long as possible to provide a sufficient retirement income later in life. Tax free cash would stay at 25% at State Pension Age, but with a higher rate if left longer, and lower rates if drawn earlier.

“We also believe the pension system should recognise that there is a need to encourage savers to provide for their very long term needs and our proposed system includes an additional annual allowance where contributions are applied to secure later life income or to meet the costs of long-term care.”