The Government should consider scrapping the 25 per cent tax-free lump sum and replacing it with a pension fund top-up at the point of annuitisation, says the Institute for Fiscal Studies.
In an interview with Money Marketing, IFS director Paul Johnson says the current benefit of accessing 25 per cent of your pension tax-free from age 55 is a poorly targeted use of Government subsidy.
He suggests that if one of the main purposes of a pension is to provide a regular annual income, offering a Government boost to pension funds at the point of annuitisation may be a better policy.
Johnson says the top-up payment could be equivalent in value to the tax-free lump sum.
He says: “The issue with the lump sum is not that it is overly generous, rather that it seems poorly targeted on the policy need. Alternatives might include an equal value top-up to the pension fund or annuity payments.”
“Without some incentive, too many people will not save for retirement. In addition, the Government wants as few people as possible to fall back on means-tested benefits. But there is a question as to whether the tax-free lump sum is the best way of achieving that.”
Johnson took over as IFS director in December after his predecessor Robert Chote left to head up the Office of Budget Responsibility.
Earlier this month, the IFS launched its first major piece of work under Johnson, the Green Budget, which echoed the institute’s call for a “coherent” tax system in its Mirrlees Review.
Johnson says he welcomes the Office of Tax Simplification’s current scrutiny on tax reliefs, which is looking into the effectiveness of 74 reliefs, including ones involving VCTs, Pets and insurance bonds. But he says it does not go far enough to achieve the overall coherence the IFS is calling for.
He says: “We would really like a review of neutrality in the system and where there are non-neutralities, they should be tes- ted to see whether they are appropriate and well justified.”
Johnson describes two inheritance tax reliefs, the agricultural and business property reliefs, as “odd” and suggests they should be ended. Both are being considered for the chop by the OTS.
He says: “They are treated more generously here than in other countries and we see no reason why you would want to keep that kind of benefit.”
Johnson says the stamp duty on housing, differing treatments of employer and employee National Insurance contributions and the exemption of financial services from consumption tax all fail to meet the Mirrlees coherency test.
The IFS put forward a tax to stand in place of VAT on financial services in the Mirrlees Review, published in November.
Johnson says something along the lines of the International Monetary Fund’s proposed financial activities tax could be the way forward.
In April, the IMF proposed the introduction of Fat – a tax on the sum of the profits and remuneration paid by financial institutions.
Johnson says: “The sector is arguably under-taxed. You cannot impose VAT on financial services as you can other things but something like the FAT would go a fair way to sorting that difference out. “There are a range of ways of achieving something which has a similar impact to VAT, which involves taxing some measure of flows or profits. We need to get that measure precisely right to make it work.”