Pension tax relief is set to take another hammering from reform-hungry politicians, with both the Conservatives and Labour setting out complex plans to cut allowances for people earning more than £150,000.
Labour has previously come under attack from the pensions industry over its plans to taper away tax breaks for high earners. The proposals, which were first set out before the 2010 general election, were torn up by the Coalition in favour of reducing the annual and lifetime allowances.
However, with voters set to go to the polls again next month, the Conservatives unveiled a strikingly similar plan to Labour’s in its manifesto on Tuesday.
And with Liberal Democrat pensions minister Steve Webb favouring a more radical overhaul that would see tax-relief paid at a flat-rate regardless of salary, further reform to the UK system is now all but inevitable.
The Conservative reform plans would see the annual allowance for tax-free pension savings gradually reduced for those earning between £150,000 and £210,000, with those earning £210,000 seeing their allowance reduced to £10,000. The proposals effectively mean the 300,000 people potentially affected will lose 50p of allowance for every additional £1 of income earned.
The Labour plans would see tax relief cut to 20 per cent for those earning over the £150,000 threshold. The Institute for Fiscal Studies says this is similar to a policy previously announced in the 2009 Budget and described by Webb as a “dog’s dinner”.
Labour’s manifesto also reiterates proposals to ensure savers are given “proper guidance” around the pension freedoms and to introduce a cap on drawdown fees to protect savers from “rip-offs”.
The IFS warns the reform proposals put forward by the rival parties risk plunging the pension tax system into “chaos”.
It says: “We risk rushing towards something like chaos in the taxation of pensions for those on high incomes. Both Conservative and Labour plans will have substantial incentive and behavioural effects for those with incomes in the £150,000 to £200,000 range – potentially bigger effects than the 45 per cent (or 50 per cent under Labour) income tax rate itself.
“This matters. Of course nobody on these sorts of incomes is going to be pushed into penury by such changes. But the undesirable distortions to savings behaviour and to work incentives have the potential to be significant.
“The two main parties seem to be competing to tie their own hands on the main tax rates while scooping up apparently free money from ‘the rich”, non-doms and tax avoiders on the other. There is a danger that the tax proposals being put forward through this general election campaign will have a long term malign influence on our tax system and economic welfare.”
Experts have criticised policymakers for prioritising political expediency over reforms to create a more sustainable, fair system in the UK.
Standard Life head of pensions strategy Jamie Jenkins says: “You couldn’t describe moving to a flat-rate as tinkering, it would be breaking the link between income and tax relief, which is a much more fundamental change which is the kind of thing we should be debating more seriously rather than what appears to be short-term tactical solutions.
“I’m not saying that flat-rate is definitely the right way, but what I’d like to do is work through the options, and look at the impacts and do some modelling to understand what behaviours would arise and what it would mean for pension saving. Those are the sort of options we should work through, rather than this tactical tinkering.
“It’s almost like tax relief is being seen as a pot to squander for other purposes. I understand that notion, but we also need to make sure we don’t create lots of complexity and difficulty.”
MGM Advantage pensions technical director Andrew Tully says the greater complexity likely to arise from the reforms will invitably put people off saving.
He says: “Given that national finances are not in a hugely strong position, reducing tax relief is probably an obvious move for them to do to fund pledges.
“But the more complex these systems become acts as a profound disincentive for the one thing we want all of our population to do, which is to have confidence and to put far more into the pension system.”
The money David Cameron hopes to raise from the pension tax relief reforms would be used by the Conservatives to increase the inheritance tax threshold, when property is included, from £325,000 to £500,000. This would mean married couples would have a shared IHT threshold of £1m.
The Conservatives claim around 22,000 families will benefit from the move by 2020.
Cameron says: “We will take the family home out of inheritance tax. That home that you have worked and saved for belongs to you and your family.
“You should be able to pass it on to your children. And with the Conservatives, the taxman will not get his hands on it.”
But the IFS says the change would “disproportionately” benefit those on higher incomes.
It says: “Since the children of those with very large estates are disproportionately towards the top of the income distribution the gains from this (and in fact any) IHT cut will also go disproportionately to those towards the top of the income distribution.”
MRM head of public affairs Havard Hughes says: “I think both sides have a real problem to make their financial programme stack up.
“They both want to spend money in certain areas, but you’ve got to get that from somewhere, and pensions can be seen as a bit of a cash cow.
“Both parties feel that they can get away with changing the tax relief regime without causing too much political fallout.”
Meanwhile, smaller parties are also looking to shake up the rules around pensions, with UKIP pledging to wind back the state pension age to 65.
The reduction would be put in place for all workers, and mark the beginning of a “retirement window”, with those retiring later able to take more state pension each year.
Ukip has also promised to make pensions cold-calling a criminal offence, as well as introducing greater funding for financial education in schools.
Ukip also backs pension freedoms, as well as the widely supported triple-lock on state pensions.
Adviser Mark Hughes, who devised UKIP’s pension policy for its manifesto, says the cut in the state pension age will be funded through savings in other policy areas.
He says: “We think the biggest losers in the pension reforms are women and manual workers. That’s because women have seen their retirement age move from 60 to 67, and manual workers have put their body through immense strain over their working life. We are treating people who have different needs in a blanket way, so we want to introduce a state retirement window.
“You will be able to take your retirement from 65 onwards. We believe that it is a fairer way, because it treats people as individuals. And we think there may even be a cost saving because people will take the option to retire early rather than playing a charade of making out they are fit for work when clearly they’re not.”
Under the plans, workers would be entitled to less if they retire at 65, similar to how current rules allow for an increase if state pensions are deferred for a year.
Hughes says: “It’s trying to be a little bit fairer, and when we’ve modelled this we have liked what we have seen, and we think it’s affordable.”
Don’t forget about the SNP…
The Scottish National Party, which could yet have a significant say in the next parliament, wants to to oppose any further increases in the state pension age.
The state pension age currently stands at 65 and applies across the UK. Under plans outlined by the Coalition Government this will rise to 66 between 2018 and 2020, before eventually hitting 67 in 2028.
Future increases will be linked to life expectancy and based on the principle that people should be able to spend about one-third of their adult life in retirement.
The SNP, which is expected to win huge numbers of seats north of the border following a collapse in support for Labour, is pushing for Scotland to be handed greater autonomy over setting its state pension age.
Scottish first minister Nicola Sturgeon says: “The Tory-Lib Dem Government’s plan to further increase the state pension age is a worry to people across the UK who are planning for their future, but the failure to take Scotland’s specific circumstances into account is particularly unfair.
“Our comparatively low life-expectancy rate is an issue which I will do everything in my power to change, but in the meantime it would be completely unacceptable for people in Scotland who have paid in to a state pension all of their lives to lose out.”
UKIP, meanwhile, wants to allow people to draw their state pension from age 65.
According to the Office for National Statistics, average life expectancy in the UK as a whole between 2010 and 2012 was 78.9 years for men and 82.7 years for women. In Scotland, however, the figure was just 76.6 years for men and 80.8 years for women.
Labour shadow pensions minister Gregg McClymont says the plans are based on “the economics of fantasy”.
He says: “The SNP are trying to have their cake and eat it.
“The state pension is simply a guaranteed payment. Guarantees are only as strong as the institution backing it and that means small nations are more exposed to financial headwinds.
Expert view: Bargaining chips for the future?
There is an “I can be more responsible than you” competition at the moment. I suspect we will hear a lot more of that.
The real issue in whether policies resonate with anybody in the wider public is whether they are accurately costed and declared. For example, the IHT proposals look as though they are going to come out of higher rate pension tax. It is that type of thing that is important to the voter to understand. Responsibility is going to be the watchword for this week, and we will see who is more responsible than others with unfunded commitments.
The bigger question is whether manifestos are really valuable in the context of what the parties will do once they get into government – that’s the prism with which we need to look at this week. Are these manifestos for government, or are they bargaining chips for a future coalition?
If the SNP are going to form some kind of government with anyone, they will have their own wish list, which may or may not include a referendum back on the agenda. Of the others, the Lib Dems are going to seek to ameliorate any of the worst excesses. We know where they want to raise taxes, and they do want to have a property tax, and a further look at the higher rate of pensions tax. That’s almost certainly going to be on their agenda if they want to form some kind of coalition with whomever but particularly with the Conservatives. But they will tend to want to pull back the other parties.
There will be more policies to come, and the reheated stuff that we are already aware of will be a pre-cursor to some reasonably high-profile news that we have not yet seen. We’ve seen some pledges on health, but we have not seen anything yet really on education, and there is more to come on migration.
But in terms of financial services, they all seem to be wanting to line up to be tougher on the sector. So I do not think we are going to get any measures that will make readers go “yippee, let’s vote for them”.
Ralph Jackson is director at Lansons
A snapshot of policies from ‘the big two’
Reductions in tuition fees, funded by reduced annual and lifetime allowances
Ban on claiming non-dom status after “a short period”
Cap on drawdown charges
A mandatory cooling-off period on pension decisions
A commitment to raising £7.5bn a year from tax avoidance and evasion
£1m inheritance tax threshold and extra childcare services, funded by reduced annual allowance
Raising 40p income tax threshold to £50,000
Raise the personal allowance from £10,600 to £12,500
A £72,000 cap on the cost of residential care