If a 55-year-old treats their pension pot like a current account, why should they get any tax relief at all? Having given freedom to over-55s in bucket-loads, the Chancellor has no option but to take some away if he wants to balance the books.
So what options does the Treasury have as it bids to fill the multi-billion pound black hole in its bold and popular pension reform programme?
Despite its protestations to the contrary, restricting the scope of the tax-free lump sum seems like the front-runner.
Given the groundswell of goodwill towards pensions since Osborne’s Budget, surely the public can be persuaded that restrictions on tax-free cash, phrased as anti-avoidance measures, are worth accepting.
So politically sensitive is the tax-free lump sum, “anomalous but much-loved” in the words of Nigel Lawson, that the Treasury went to great lengths to present it as untouchable.
“We are not going to get rid of the 25 per cent tax free lump sum. It is a key part of the pensions system,” said a Treasury spokesman in response to my story that it could be restricted in future.
But the Treasury’s denial is not completely cast iron. And restricting tax-free cash is probably one of the most sensible means of stopping the tax leakage that would follow if nothing is done.
We all know something will be done – there is simply too much at stake. If even a fraction of those over 55 start to sacrifice salary in a big way into pensions, billions of pounds will be lost.
It seems to me the Treasury’s options are few, and all have their negative sides.
Most of the savings from salary sacrifice are in reduced National Insurance for basic rate taxpayers. Imposing employer and employee NI on pension contributions would make the practice less attractive, but would be a massive tax on businesses and individuals.
The Chancellor could say you cannot pay any more in once you have drawn benefits – fair enough, but bad news for those looking to clear mortgages or pay education fees in their late 50s – hardly the flexibility agenda promised in the Budget and not very helpful to the concept of phased retirement.
Anti-avoidance measures could slow the tide of tax avoidance, but would be massively complex to enforce. What’s more, they would create huge uncertainty about what pension contributions are and are not permitted – hardly chiming with the simplicity agenda.
Yes, someone earning £40,000 at 54 and then suddenly reducing it to £12,000 at 55 would smack of trying to game the rules, and you could create some principles to challenge that. But how many top earners do something similar anyway already? How effectively would it be enforced? And what about the fact that people do start to pay more into their pensions as they wake up to their own personal retirement savings crisis? Do we want to stop people paying more in just when they really want to?
I am also not convinced how you can target one group who have little or no pension, yet leave other groups getting lots of pension and benefiting from no NI and the tax-free lump sum.
With DB schemes paying in up to 30 per cent of salary without NI and benefiting from tax-free cash, what is an acceptable level for those in humble 8 per cent DC schemes?
And what of those employees of schemes with really generous DC schemes. Under the new rules, an over-55 whose employer makes a 20 per cent DC contribution is effectively getting that as cash. Should that stop?
It feels like tax-free cash could be both the carrot and stick to promote good behaviour. Preventing tax-free cash on future contributions once you have drawn benefits doesn’t sound so bad after all. Still bad for those looking to pay off debts in their 50s, although some accommodation could be made for what they have saved to date. And it would garner some bad press. It might also feel like the thin end of the wedge for tax-free cash per se, and plays havoc with phased retirement. The problem is, none of the options are that palatable.
But it would stop people washing money through the system, and allow Osborne’s welcome reforms to progress. Either the Treasury are being economical with the actualité or they have thought of something the rest of us can’t conceive of.
John Greenwood is editor of Corporate Adviser