Think-tank: Govt should ignore flat rate and abolish tax-free cash

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George Osborne should resist moving to a “misguided” flat rate of pension tax relief and instead cut or abolish tax-free cash, an influential think-tank says.

In recent weeks it has emerged the Treasury’s preferred option for a new system is the flat rate of relief championed by much of the industry.

But the Institute of Economic Affairs says a flat rate would be “incredibly complex” and detach pensions taxation from “any reasonable economic principles”.

It says the current system has a sound logic as those on high incomes receive more relief because they pay more tax over their lifetimes.

The think-tank adds HM Revenue & Customs would need to introduce new complicated rules to stop employees working around a flat rate.

It favours retaining both the annual and lifetime allowance but removing the 25 per cent tax-free lump.

It says: “The tax-free lump sum allows contributions to sidestep the tax system completely – in effect creating an EEE regime for that quarter of the pension pot. This then necessitates a huge volume of tax regulation to prevent perceived abuse.”

Lowering or abolishing the lump sum would “hugely reduce the ‘benefits’ that flow to the rich from tax relief”, the IEA says.

It also takes aim at pension Isa champion Centre for Policy Studies’ Michael Johnson and others’ assertions of the cost of tax relief. It says highlighting the gross cost of tax relief is “totally wrong”.

It says: “The reports of the costs of pension tax relief we often hear about are not judged against sensible counterfactuals and vastly overstate the cost relative to a neutral system of taxation.”