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Malcolm McLean: Simpler pension tax relief is only fair

Pension tax allowances have created a complicated system that is not working in the interests of consumers

Being able to get tax relief on contributions to a pension scheme is probably something that we tend to take for granted and don’t value enough.

The relief provides an incentive to join a pension scheme in preference to other types of investments and, without it, our pension pots and overall income in retirement would be considerably lower than they are in consequence.

But this all comes at a cost to the taxpayer – at the last count £24bn for individuals and another £17bn for employers’ contributions – and it is entirely right that the government places limits on the maximum amounts any one person can receive by way of tax relief.

These limits – or allowances, as they are referred to these days – have their origins in the big “simplification” exercise in 2006, when the notion of having both an annual allowance and a lifetime allowance came into force.

What future for pension tax relief?

Unfortunately, since then, things have hardly stood still. The levels of both allowances being adjusted with bewildering rapidity to the point where savers don’t know where they stand from one year to the next, or how much they can safely put into their pension without incurring a hefty tax penalty.

What allowances do we need?
Now that the annual allowance has been reduced from its peak of £255,000 to £40,000 and the lifetime allowance from £1.8m to £1.03m (rising to £1.055m from 6 April 2019), do we need both?

The existence of the LTA is also challenged by many, given the depressing effect it has on saving, allegedly causing many doctors and other professional workers to prematurely retire from work. Such individuals would benefit from taking good advice as it is possible that they might be giving up valuable benefits just to reduce tax.

The government has compounded the problem by adding two new fairly obscure allowances into the mix – the tapered annual allowance for high earners and the money purchase annual allowance.

The tapered annual allowance for high earners is frankly a nightmare of complexity. Apart from experts in this field, I am not sure there are many people who fully understand how the taper works, which income has to be taken into account (no, it’s not just earnings) and the rest of the overcomplicated rules that have to be applied. Again, those affected by the tapered annual allowance would benefit from expert advice as it is possible to carry forward unused relief from earlier years.

Ros Altmann: Pension tax relief will be left well alone

Also, other than a minority of experts in this field, does anyone understand the concepts of mandatory and voluntary scheme pays and the different deadlines for election for scheme pays and payment of annual allowance tax to HM Revenue & Customs? And what about the MPAA?

According to recent figures from HMRC, the number of individual pension freedom payments hit a record 628,000 in the final quarter of last year. That, in itself, is not necessarily a bad thing – yet you do wonder just how many of the thousands of over-55s who are dipping into their pension pots while continuing to benefit from workplace pension contributions are at risk of a shock tax charge.

A simpler system
Many will be totally oblivious to the fact that by even withdrawing a very small amount from their pension pot that would be subject to income tax – for example, perhaps for a holiday – they could inadvertently be triggering the MPAA.

This means they are effectively restricting the total that can be paid into their defined contribution pension plan without a tax penalty for every year from then on to £4,000. This is a big drop from the £40,000 that would otherwise be allowed – all that means for their future retirement plans and level of pension income in retirement.

There is no doubt we need a simpler system, one which the saver can easily understand and not fall victim to the many hidden traps that currently lie within it. Surely it can’t be right that so many people appear to be unwittingly overpaying tax, bolstering the coffers of the Treasury at the expense of themselves.

Malcolm McLean: How to make pensions system fairer for women

There needs to be a comprehensive review of all these allowances. Do we need all of them? Would one smaller annual allowance not suffice? What damage are they inflicting on people’s retirement plans? Is there not a better way?

Assuming at some stage the government can lift its mind from Brexit, I would urge it to look at a system which is not working in the interests of consumers and needs to be sorted as soon as possible.

Malcolm McLean is senior consultant at Barnett Waddingham



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There are 6 comments at the moment, we would love to hear your opinion too.

  1. Malcolm,

    I really experts such as yourself would not keep parroting the line that pension tax relief costs the government X amount of money.

    Pension tax relief costs the government absolutely nothing for the following reasons which people seem to have lost sight of.

    1.) The government has no money of it’s own, it’s OUR money they are spending. So how can the government “give” us anything, when it’s our money in the first place…?
    2.) Tax relief is not giving money back, it’s simply about not taking as much in certain areas in the first place.

  2. It can also be treated as deferred taxation as after the 25% (TFC or what ever you wish to call it now)there is a tax liability in withdrawals, and then it is our job to arrange this in the most suitable tax efficient way for our clients

    • Yes,of course, Clive it could be construed as deferred taxation but it is not always a straight swop. Many workers in the higher rate tax bracket get tax-relief on their contributions at the 40% rate but only pay at 20% on their pension income after finishing work.

      But on this and Duncan’s point (on which I don’t disagree) the article was not really about the costs involved, rather the confusion being caused by now having four allowances, the overlaps between them and the damage they can cause for pension planning – especially the MPAA.

      • I do not disagree on the allowances Malcolm, especially when you consider how the government are always on at people to save more.

        Whilst I think there is some justification in having an LTA, the AA is simply hopelessly complicated, especially when it comes to tapering and the chances of any client who isn’t well informed on it understanding what they do/do not need to do is nil.

        I regularly run seminars for state sector workers who have literally no clue that they have broken the AA this year and frequently in preceding years and with the tapered AA, their only real option is to pay someone to work it all out for them every year so they know what they need to do.

  3. The most pernicious limit is the LTA (so start by removing that), followed by the tapered input allowance for high earners.

    The MPAA was designed to restrict TFC recycling and is, perhaps, difficult to challenge, though a better measure might have been to ban any TFC allowance in respect of benefits accrued from all contributions made after the first TFC withdrawal.

  4. I’m not sure where your get the £24bn cost for employee contributions. You seem to acknowledge in comments that deferred taxation applies although not full recovery.

    I can’t accept the £17bn relief on employer contributions. This arises as a result of pension contributions being a business expense in the same way as salaries. Are you claiming businesses save billions by paying salaries? It’s all employee remuneration.

    Having said that, I do agree that tax relief should be simplified. We tried that not so long ago. As I recall, the consultation lasted longer than the legislation.

    On Duncan’s point, unless you have an arrangement with HMRC that paying tax is voluntary, tax relief is exactly the same as the Government making a payment. Of course it is all taxpayers’ money but the the Government are responsible for distributing it.

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