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Lump light

But the report, which is the committee’s response to the Government White Paper on pension proposals, has caused outrage by recommending a review of the tax-free lump sum, which many see as one of the key reasons why people save in pensions. It also recommends a review of higher-rate tax relief.

The debate really started recently in the Pension Commission’s second report, which states: “Pension tax relief is costly, poorly focused and not well understood.” It also says the Revenue estimates that the total cost of pension tax relief is around 12.3bn a year.

The select committee’s report says: “We recommend that the Government responds to the Pension Commission view, highlights whether it believes the relief could be targeted better and whether some of the resources devoted to tax relief might be used to finance the increase in state spending on pensioner benefits.”

Informed Choice managing director Nick Bamford says debate on pension tax relief and, more specifically, tax-free lump sums is hardly new but the change of title from “tax-free cash” to the Government-speak “pension commencement lump sum” has been fuelling sugges-tions that many in Westminster want to do away with it altogether.

He says: “I struggle to believe that what politicians say is true when they come up with statements like, ‘to see if resources can be better spent on increasing state spending on pension benefits’. Am I the only cynic who believes that there is no direct correlation between taxing the lump sum – because what you are hearing is code for that – and increasing state pension benefits?

“It is simply about the direction of Government spending rather than a trade-off between tax-free cash and additional state pension benefits. The question is, will the tax pounds saved, if the pension commencement lump sum is taxed or abolished, truly be used to enhance pensions from the state?”

The report from the select committee comes just three weeks after the ABI launched its Save More Now campaign. There have been concerns that with all the hype surrounding pension reform, many potential savers will sit back and wait for the Government to implement pension changes without planning for the future.

Of course, the promise of some sort of pension tax relief is a huge incentive to save in a pension.

Scottish Life head of pensions strategy Steve Bee says tax-free cash is the only real incentive to save in a pension. He says: “The deal is, if you save in a pension, you are only taxed once. Any change to that will spell the death of pensions. The only real benefit of a pension is the tax-free cash. It is the only differentiator from other investment. Why put on this pension straightjacket? If they get rid of it, the Government may as well take away all the pension legislation as we simply will not need it.”

Hargreaves Lansdown head of pensions research Tom McPhail says: “The system is anachronistic and anomalous. However, it is also certainly true that any moves to diminish the tax breaks on pensions would have a catastrophic impact on investors’ propensity to save.”

Bamford says this kind of move will almost certainly be a disincentive to save but there will probably be some sort of get-out clause for civil servants similar to when judges were exempted from the lifetime allowance rule.

Richard Jacobs Pension and Trustee Services director Richard Jacobs says: “This would be the final death knell for pension saving as the tax-free lump sum is one of the biggest incentives to save. The day that civil servants give up their generous schemes is the day that this can be allowed to happen.”

Scottish Equitable pensions development manager Rachel Vahey does not see any logical reason for redirecting funds from pension tax relief into the state. In fact, according to a report by the Pensions Policy Institute, entitled, An Evaluation of the White Paper State Pension Reform Proposals July 2006, if the White Paper proposals are implemented, there will be no net increase in Government spending on pensions until 2030 and even then the increase will only be around 0.1 per cent of GDP. This is because of the partial abolishment of contracting out, as outlined in the White Paper.

The report says that in the first year of these reforms, that is the target 2012 date, the proposed abolition of contracting- out into money-purchase pension arrangements looks like it will result in an increase in Government revenue of 4bn.

The report says: “The increased revenue from abolishing contracting-out for defined-contribution arrangements more than covers the projected costs of state pension reform until state pension age is increased. After 2030, the cost of the reforms is only 0.1 per cent of GDP up to 2050.”

Independent pensions consultant and Pensions Action Group campaigner Dr Ros Altmann says: “From what I have heard, it is most likely that tax-free cash lump sums will be abolished although this raises less revenue for the Treasury than taking away higher- rate tax relief.

“Personally, I would rather we got rid of that, kept the lump sums and get rid of annuitisation. I would introduce a citizen’s pension which would get rid of means-testing. Then the industry could safely sell pensions to anybody.”

In most cases, the way to solve a problem is not just to throw more money at it. Bamford says the NHS has a bigger spend than the national budget of Thailand. To him, this is hardly an example of shrewd spending. It would seem that throwing big amounts of money at the UK’s state pension problem is not necessarily the answer.

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