Chancellor George Osborne has fired the starting gun on radical proposals that could rip up the pensions tax system.
In a consultation published as part of this week’s Budget, the Conservatives’ first in 18 years, Osborne says he wants to create a “lasting system” that “stands the test of time”.
Pensions experts have long called for an end to successive Governments tinkering around the margins of the pension tax regime to make short-term gains.
The Budget document points to changes to the annual allowance on pension contributions that will lead to “agony” for the industry. It also reveals the Government has caved to pressure from the Association of British Insurers and delayed the introduction of the secondary annuity market.
So, is the Government’s insistence on the rapid introduction of far-reaching reform finally catching up with it?
Further radical change
The Chancellor has announced a consultation that will look at moving the taxation of pensions closer to the Isa regime, where tax is paid on contributions, not on withdrawals.
In his Budget speech, Osborne said: “It’s time to look at the other end of the age scale, to those starting to save for a pension. The truth is Britain isn’t saving enough and that’s something we need to fix in the economy too.
“I am open to further radical change – pensions could be treated like Isas. You pay in from taxed income and it is tax-free when you take it out and in between it receives a top-up from the Government.
“This idea and others like it need careful and public consideration before we take any steps – this green paper that asks questions, invites views and takes care not to prejudge the answer.”
Cicero Group director and chief corporate counsel Iain Anderson says: “This is the likely pensions revolution the Tories have been thinking about since before 2010 and now, as a majority, they are getting the opportunity to move towards a regime they philosophically are in tune with. This is not the end of pensions but an equalisation in fiscal treatment with the Isa flexibilities.”
Centre for Policy Studies research fellow Michael Johnson says the potential changes are “absolutely fundamental” and the “only card Osborne has got to get himself into a balanced budget position ahead of the next election.”
The Government says a new system should be simple and transparent, promote personal responsibility, encourage more saving and be sustainable.
But at the same time, the Budget confirmed complicated changes to the annual allowance on pension contributions in the short term.
Employees whose “adjusted income” – a combination of salary and pension contributions – is over £150,000 a year will see their annual allowance drop.
For every £2 of adjusted income over £150,000, the annual allowance will fall by £1 down to a minimum of £10,000 for those earning over £210,000.
Former pensions minister Steve Webb called for fundamental tax reform while he was in office, including introducing a flat rate of tax relief. But he says the Government’s dual announcements are contradictory.
He says: “I have no problem with an open-ended green paper but the Government is doing that on the same day as going ahead with the tapered annual allowance which is the exact opposite.
“We may get to a better place but we’ll have to go via an obscure route to get there – we’re going to have to go through agonies to get to a more sensible point.”
The consultation, which will inform a green paper, gives no indication of the Government’s direction of travel and leaves the option of no change at all on the table.
For instance, the document says moving pensions further towards Isas’ taxed-exempt-exempt model – championed by the Centre for Policy Studies – could be simpler for consumers. But at the same time it notes the current system promotes leaving money in pension pots.
The consultation also outlines issues that would need to be clarified following reform. These include the potential impact on investment markets, how defined benefit pensions would be treated and how the wider tax system will be affected.
Retirement Advantage pensions technical director Andrew Tully says: “This is a very wide consultation which is asking for views on a wide-range of options.
“It is a big deal which could fundamentally change how people save for their retirement in future. A move to an Isa-style system would come with many complexities, as existing pension savings would need to be ring-fenced.
“And it is far from clear how a defined benefit scheme could be converted to an Isa-style system. However it is positive the Government is moving more slowly and seeking wide views on such a dramatic change.”
Dentons Pension Management director of technical services Martin Tilley warns the sweeping changes that came into force in April will also need to be reconsidered in the light of tax reform.
He says: “Whilst the questions posed in the Treasury document focus on pension reliefs, if a radical overhaul is proposed it is difficult to see how these can be considered in isolation and this could call into question the retention of the recent pension freedoms and reduction on tax on death benefit reforms.
“Successive governments have raised but struggled with a system that achieves the objectives of dealing with the anomalies of pension tax relief whilst not moving radically away from the existing regime. The need to ensure that any new system is simple to understand and administer is also crucial.”
Webb adds the introduction of a new system would be “pretty grim” as pension companies struggle to serve two cohorts of customers operating under conflicting rules.
The consultation closes on 30 September.
Tradeable annuities delay
Another radical Government proposal could also come unstuck as the Treasury announced a rethink on the plan’s implementation.
Since the recent consultation in the March Budget, critics have warned of the high risk of consumers losing out.
But the Government has kicked the controversial policy into the long grass, citing concerns over customer protection not being in place by the original 2016 deadline.
A functioning secondary annuity market is now mooted for 2017 with further measures announced in the autumn, the Treasury says.
The Association of British Insurers – which recently called for a pause in the rollout – says the new timetable was a “very welcome move”.
Tully says: “There is a real danger that people could get poor outcomes from trading in their annuity, so we need to take time to consider how people can get a better deal.”
But Just Retirement director Stephen Lowe says: “I’m disappointed the delay is as long as suggested.
“I understand the importance of getting this right, but the important thing is to keep the pace of the thinking and the consultations running to give more time for insurers and others to participate and build the necessary infrastructure.”
Alistair Cunningham, director, Wingate Financial Planning
Tapering the annual allowance is coming in at the same time as the consultation paper on “strengthening the incentive to save”. Maybe the best way to encourage long-term savings is to introduce a long-term framework enshrined from future change.