For pension providers to call for a cut to higher rate pension tax relief sounds like turkeys voting for Christmas. In fact, it sounds like turkeys voting for Christmas, then popping to Tesco to stock up on crackers and cranberry sauce.
The billions the Treasury spends each year to encourage people to save into a personal pension are, understandably, cherished by the industry.
They are as generous as they are unique. After all, how often does HM Revenue & Customs hand out free cash to people who want to make themselves better off?
But there is a problem with this uncharacteristic largesse. The jury is still out on how effective tax relief is at persuading people to save for their retirement.
The Pensions Policy Institute’s view is that, despite all the advantages tax relief offers, it is poorly understood and there is little evidence it encourages pension saving – especially among low and medium earners.
In other words, pension tax relief is an expensive but inefficient incentive.
Auto-enrolment is now getting more people into the pensions habit. But its success, and the very need for a scheme that railroads people into pension saving, is a tacit acknowledgement of the failure of tax relief to change the behaviour of non-higher rate taxpayers.
The jury is still out on how effective tax relief is at persuading people to save for their retirement.
Improbable to inevitable
According to the National Audit Office, pension tax relief in its current form – which gives savers relief at their marginal income rate – costs the Exchequer £35bn a year.
Chancellor Philip Hammond is widely thought to have been eyeing a cut to this improbable generosity for some time. Ever since his humiliating post-Budget U-turn on National Insurance left the Treasury with a £2bn funding gap, a reduction in pension tax relief has begun to look ever more inevitable.
The only questions remaining are when and how the cuts will come. Sadly there is precious little clarity, let alone a timetable, on offer at present.
Earlier this month, work and pensions secretary David Gauke said changing pension tax relief is “somewhat daunting” and that no “fundamental” reforms are imminent.
Fast forward a couple of weeks and the Government surprised many by announcing plans to force six million people currently in their 40s to wait an extra year before they can claim the state pension.
The plan, which will raise the state pension age to 68 seven years earlier than originally proposed, will save the Exchequer £74bn by 2045.
But such long-term savings are unlikely to assuage politicians’ perennial love of tinkering with the pensions system. If tax relief reform is off the table for now, let’s not kid ourselves that this is anything other than a brief hiatus.
Ripping off the plaster
Whatever form the changes take, higher rate taxpayers have most to lose, as they benefit most from the current system.
One suggestion doing the rounds is that the marginal rate system could be replaced by a single rate of pension tax relief. The PPI estimates that, if this universal rate were set at 20 per cent, the cost to the Treasury could be slashed by £13bn a year. By contrast, a single 30 per cent rate would leave the annual cost broadly unchanged.
Both options would see higher rate taxpayers take a hit, but clearly a 30 per cent rate would be less onerous. Such a rate would reduce the relief offered to higher earners by a quarter but deliver a 50 per cent boost to the relief available to basic rate taxpayers.
Which rate the Government goes for would reveal its priorities: is it merely to cut costs or is it to provide a more equitable distribution of the benefits of tax relief?
Painful though the introduction of such a system would be for pension providers, advisers and their clients, it would be better for any reforms to be introduced in one go rather than in a series of creeping cuts.
But before we rush to rip off the plaster, we should consider the wider pensions tax landscape, which has been made unnecessarily complex by years of short-termist tinkering.
Such a decision is too important to be made by politicians alone. An independent pension tax commission should be formed to weigh the Government’s desire to save money against the long-term problems being stored up by the large numbers of people under-saving for their old age.
Ultimately, the interests of Westminster and the pensions industry might just coincide.
Politicians argue the cost of pension tax relief in its current form is unsustainable and many professionals now question its efficacy. Yet both want more to save more into their personal pensions.
Far better for the two to work together on devising a reform that is workable and definitive, to bring clarity and, above all, an end to the Government’s constant meddling.
Unlike Christmas, though, such a grand bargain should come once in a generation, not once a year.
John Fox is director of Liberty Sipp