So, here we are again with rumours of the possible removal of higher-rate tax relief on pension contributions and the loss of the 25 per cent tax-free cash lump sum on retirement. These are almost annual rumours in the run-up to the Budget.
What is different this time is that Treasury chief secretary Danny Alexander has reiterated the Liberal Democrats’ commitment to restrict pension tax relief for higher-rate taxpayers.
Higher-rate taxpayers cost the Government an estimated £7bn a year in pension tax relief, so might there be some substance to these rumours, especially with the Government’s finances in such a perilous state?
All the discussions about tax relief on pension contributions forget to mention that when pensions come into payment, they are taxed as income, so, in reality, pensions are only deferring the Government’s tax take.
Now, to give another incentive for us to save now and spend later, we are currently allowed to take 25 per cent of the pension fund as a tax-free lump sum. For many ’If the Govern-ment removes higher-rate tax relief and the tax-free lump sum, I predict a massive reduc-tion in saving’people, this gives them a lump of cash that can be used to pay off any loans or mortgages still remaining and basically get themselves financially sorted at the end of their working lives.
“If the Government removes higher-rate tax relief and the tax-free lump sum, I predict a massive reduction in saving”
Confidence in pension saving has been badly damaged over the years by a combination of constant rules changes and unnecessary complexity, by all recent governments, overcharging by pension companies, poor investment returns from global equity markets for that last 12 years and the dramatic crash in gilt yields, which has had the effect of reducing the final pension/annuity that people receive. For those few people left saving into pensions, it looks like the Treasury wants to stop them from doing so as well.
If the Government does remove higher-rate tax relief and the tax-free cash lump sum, I predict a massive reduction in future pension savings. This, of course, fits perfectly with the Government’s desire for people to spend and not save in order to help kickstart the economy. Another short-term policy which is against the country’s long-term benefit.
The irony is, of course, that Nest is about to be launched and all employers will be forced to join their employees into the scheme (or equivalent). Employees then have to opt out of the pension within the first month, otherwise any money contributed will be locked into the pension.
The Government needs to realise that the whole pension system is broken and needs to be reviewed in light of the modern world and flexible working practices. However, the last time a politician was given the task of thinking the unthinkable with pensions, Frank Field, he was given the sack for his conclusions.
There are rumours that the Government is considering reducing pension tax relief in this month’s Budget. Is the Government right to consider reducing the amount it spends on higher-rate tax relief?
The state provides tax relief to encourage good behaviour or to make the tax system fairer.
Tax relief is a cost – tax foregone has to be made up by other taxpayers. My tax relief is your tax burden.
So, how do we evaluate pension tax relief? It is good public policy to encourage people to save for retirement. If people do not, they become a burden on the state as they will claim mean-tested benefits – not just the pensioner-related means-tested benefits but housing and council tax benefits among others. Pensions lock your savings away, so there is a case for compensating people for this restriction.
’Tax relief is a cost – tax foregone has to be made up by other tax-payers. My tax relief is your tax burden’
In an increasingly DC world, with longevity growing, there is therefore a strong argument for encouraging pension saving through tax relief. But that does not mean that it should be open ended.
“Tax relief is a cost – tax foregone has to be made up by other taxpayers. My tax relief is your tax burden”
Once people are saving enough to lift them clear of means-tested benefits and provide a reasonable post-retirement income, should other taxpayers still bear the cost of further relief?
Here we need to ask the fairness question. Pension tax relief is at the marginal rate. As a higher-rate taxpayer, it costs me 60p to put a pound in my pension pot. But it costs my lower-paid colleagues 80p as they are pay a 20p marginal tax rate. What unites us is looking jealously on those on the 50p tax rate who can save a pension pound for just 50p.
Two-thirds of tax relief goes to higher-rate taxpayers, yet only one in seven taxpayers pay either higher or additional-rate tax. Of course, pensions in payment are taxed – if not the lump sum. But the vast majority of those who get higher-rate tax relief before retirement pay at the standard rate when they retire.
Pension tax relief is therefore about the least progressive element in our tax system. The cap introduced by the last government was absolutely right. With spending cuts and the VAT increase hurting the poor more than the better off, any government looking to raise revenue should look hard at further change such as further restrictions in the annual limit that can be claimed.
But it should not all disappear into deficit reduction. A good chunk should stay in pensions either by helping ease the intro-duction of the £140 flat rate or by skewing the benefit down the income scale.