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Hammer blow: Politicians use ‘cash cow’ pension tax relief to fund election bribes

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.

Chaos

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.”

Fundamental reforms

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.”

IHT reforms

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.”

UKIP

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’

Labour

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

The Conservatives

£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

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Comments

There are 8 comments at the moment, we would love to hear your opinion too.

  1. Whatever else anyone may think of UKIP, at least the sources of funds for their spending proposals are about as clear and straightforward as they can possibly be. Withdrawing from the EU might well provoke some market turmoil but only for a finite period. We always managed in the past without being a member of the EU. Have the benefits outweighed the costs (the crucial Cost:Benefits Analysis that nobody seems to want to undertake)? UK plc would get over it and the vast sums of money saved would surely cushion the process of adjustment.

    As for foreign aid ~ on what basis, to cite just one example, are we giving billions of pounds to a country like India that even has its own space programme? It’s a crazy waste of money that could be far better spent here.

  2. And that surprises anyone?

    Journalists can do us all a favour; instead of assuming we are all fascinated by this garbage perhaps they could shine a light on the venality, lies and financial chicanery that is Westminster’s greatest talent. (Along the lines of the Daily Telegraph’s expose of MP s expenses).

    Instead of just focusing on the deficit – which in the scope of things is only about a quarter of the problem why not shine a light on the National Debt? After all the deficit is only the difference between what we earn and what we spend. The debt is the total that we owe.

    It is like saying you have a £30k salary, but spend £32k per year and you are going to try hard not to spend the extra £2k. But what about the £45k you currently owe on your credit card? How are you going to get rid of that, particularly as you are paying almost £7k p.a in interest?

  3. Salivating MP’s and the pension funds of the “rich”!
    It is now the case this country is unable to satisfy its needs though taxation of income. It now intends to specifically exclude some “rich” people from tax breaks enjoyed by everyone else.

    The fact of the matter is GB plc spends beyond its income. It is time to balance the books by cutting back on the excesses not castrating those that seek to save for their retirement.

    The fair and reasonable arguments are lost and in the thinking in this space. Where are the rewards for creating wealth and employing people? You are labelled as “RICH” and become the target of the MP’s.

    Their view being that as you have accumulated wealth in spite of their punitive tax laws, its time now to heap on even more burden. Capital taxes will be next.

  4. Julian

    If I may say your advocacy of UKIP is typical of the myopic stance that acolytes of this potentially racist and definitely xenophobic and according to many, unpleasant organisation stands for.
    The European ideal is still basically in its infancy. How long did it take the USA to establish itself? Europe has not even been running 50 years. We are on a journey. Europe is the largest single trading block in the world. Europe is the centre of the Universe. The vast majority of major inventions, culture, social and political developments emanate from Europe.

    Just as in the US – we are having some difficulties, but once we are properly aligned the prosperity and security of future generations will be assured. Not to mention the fact that after some 2,000 years there will no longer be internecine strife – which is another point that those who eschew Europe overlook. The naysayers suffer from a lack of vision. It is time to move on we no longer rule the waves. Indeed the boy scouts have a bigger headcount than our armed forces nowadays – but an integrated European Army – well that could be another thing.

    Of course I entirely agree with you regarding Foreign Aid, but it does highlight what clots our Government is – no other European country throws away as much. Perhaps if we were integrated with Europe we might waste an awful lot less!

  5. Politicians constantly bleat on about the level of tax relief claimed by high earners.

    They fail to mention the level of tax used to subsidise local authority, civil service and MP pension schemes.

  6. It is a classic stealth tax. A rise in income tax = controversy. Ending the daft exemptions from VAT = controversy. Reducing lifetime allowances and withdrawing tax relief = no controversy, as it takes too long to explain and it doesn’t affect journos or MPs.

    At the rate things are going, effectively banning high-earners from saving via pensions might be a blessing in disguise. They may have to save money in their own hands with all the extra tax on income and gains that implies, but when the Government reduces the lifetime allowance to £250,000 with no transitional protection, or withdraws the new State Pension from anyone with a pension fund above £150,000, or decrees that all pension income will be taxed at the highest rate at which tax relief was granted regardless of other income, at least they can wipe their brow and thank God they stayed out of it.

    These may be rather extreme predictions and I am being deliberately Cassandraic by saying “when” rather than “if”, but can anybody say, hand on heart, that they can’t see them happening in the next 30 years, given the current direction of travel? Cassandra was right, remember.

  7. Whilst I do not agree with the somewhat extreme representations made, it does seem fundamentally unfair if pension relief is not given at the highest rate of tax paid, and even more unfair that the Lifetime Allowance has been progressively reduced so that it impacts on more and more people. At best it requires those who have already saved to potentially suspend future contributions and reduce their risk in order to stay below the newly reduced allowances, and at worst it can penalise people for decisions they have made when the rules were different and who now exceed the allowance and who cannot undo their previous funding and investment decisions. There are some fundamental issues that need solving in relation to the National Debt and the deficit, but it appears unjust to adopt such populist targeted penalties on people who may have thought they were previously saving responsibly for their futures.

  8. I also wonder how much of the “tax loss” relates to those with no earnings contributing £3,600 into a personal pension?

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