Apart from the provision of tax-free cash, the only real advantage we have when saving in a pension is that we get to choose when we pay the tax on our income. If we defer income by saving in a pension, we do not escape paying tax on that income, we simply defer the payment of tax until later on in life.
The special deal we get when saving in a pension (apart from the tax-free treatment of cash sums) is that we only pay tax once on our earnings while we are on the planet and in this place called the UK. We either pay tax on our income and spend it or save it in conventional savings schemes or we can choose to defer some of our income by saving it in a pension scheme. If we do that, then we do not pay tax on that deferred income until we start drawing it when we are older.
There are two ways that any Chancellor can arrange things for us so that we only pay tax once on our pension savings. One is to ask us to take a leap of faith and pay into our pension savings from our taxed income, like we do if we are saving in a building society savings account or something.
If pensions were like that, then we would be relying on a promise that future Chancellors would not tax us on our pensions when we finally come to draw them decades hence. I do not know about you but my view would be that the risk of being taxed twice on your pension savings would be on the high side in that kind of arrangement.
The second and more reassuring way of convincing us that we will only be taxed once on our income if we save in a pension is, of course, to let us off paying tax on the way in. We can do that safe in the knowledge that, as sure as eggs are eggs, we will be taxed on the way out.
And that, as everyone knows, is the way our pension system works today. We have the benefit of only being taxed once on our income if we save in a pension.
By having this arbitrary age of 75 (slap in the middle of the period that many will call their retirement) where people reach a sort of Hobson’s choice moment with regard to their pension savings seems really unhelpful to me. Why should 76-year-olds have different rules applying to them than 74-year-olds? Or, to put it another way, why should some people be taxed twice on their pension savings?
Steve Bee is head of pensions strategy at Scottish Life