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Nic Cicutti: Steve Webb needs to be more radical on pension tax relief

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Where, precisely, is Steve Webb steering pensions policy? In the past week or so, the pensions minister has been setting out his stall in a series of newspaper and TV interviews, including one with Money Marketing.

I will look at some of those policy ideas in a second. But first, it is worth noting that his choice of media – and what elements of his grand plan he coyly unveils in each of them – is fascinating in itself.

For example, I don’t believe it was an accident that the Daily Mail became a recipient of Webb’s suggestion that wage-earners in the 40 and 45 per cent marginal tax brackets should lose some of the tax relief on their pension contributions. The pensions minister told the Mail he supported a 30 per cent rate of tax relief for all savers, regardless of their income.

The potential sop to Mail readers was his suggestion that the £1.25m cap on pension pots should also be scrapped. In other words, “strivers” can save as much as they like without incurring a 55 per cent tax charge on the non-capped amount.

Elsewhere, Webb told Sky News that he thought people should be told how long they are going to live in order to help them make more accurate financial projections.

This raises the question of why people in manual occupations, who are much more likely to die younger, should be forced to wait as long for their state pensions as those who sat at a desk all their working lives. But I don’t suppose he wants to explore that particular avenue right now.

Meanwhile, Webb’s proposal to remove the cap would have only a minimal effect on Mail readers themselves: according to HMRC’s figures, a £1.25m pot might provide £62,500 in annual income with no tax-free lump sum or £46,875 if you do take the 25 per cent.

Either of these retirement incomes are way above what the near-totality of Daily Mail readers will ever receive. Still, if you want to take the sting out of an idea by dressing it up as something else, this is the way to do it.

It is also true that the case that removing higher rate tax relief for pension savings is not new. It has long been part of Lib Dem policy, albeit without reference to the equalisation of relief at 30 per cent.

Pensions expert Ros Altmann has also long argued in favour of scrapping higher rate tax relief. She points out that of the estimated £35bn – according to the Pensions Policy Institute – handed out by HMRC in relief on tax contributions, half this amount goes to top rate taxpayers.

Bear in mind that this group makes up just 14.7 per cent of the total tax-paying population in the UK, 4.3 million out of 29.3 million.

Moreover, most of this money is not recouped from pensioners either, due to what Ros has previously called “enormous amount of leakage in the pensions tax system.” Age-related tax allowances ensure many pensioners escape tax altogether and only 2 per cent of pensioners pay tax at the top rate.

Couple this with the 25 per cent tax-free lump sum they stand to get, not to mention now being able to take all of the pension pot in cash while paying only the marginal rate they are on at retirement, and you can see how this tax relief is skewed in favour of the better off.

In its report in July last year, the PPI was the first to recommend the notion of a 30 per cent “equalisation” in tax relief and it is this ball which Webb has decided to pick up and run with.

What he is ignoring, however, is another element of the PPI’s report, where it also recommended a cap on the 25 per cent tax-free lump sum

According to the PPI, three quarters of pension savers have a lump sum of under £40,000. They get one quarter of the tax relief on lump sums. Meanwhile, 2 per cent of lump sums are worth £150,000, but they receive almost one third of all the lump sum tax relief.

Its report recommended either reducing the tax-free lump sum to 20 per cent or capping the size of the tax-free lump sum to £36,000. In the latter case 75 per cent of lump sums would still be paid uncapped.

Raising the tax-free cap to, say, £50,000 or even £60,000 would leave even more lump sums to be paid without a tax charge, while still saving HMRC at least £1bn each year.

If Webb wanted to be truly radical, he could pick up on this idea too, perhaps using some of the savings to introduce another of Ros Altmann’s proposals, which I have long supported, that of a matching scheme for contributions into pensions.

For example, anyone on lower rate tax could receive a £1-for-£1 matching relief into their pension from HMRC up to a limit of, say £5,000 a year.

If Steve Webb is genuine about ensuring the vast majority of UK citizens enjoy a decent retirement income, he needs to stop looking over the shoulder at his current coalition partners and think of where he and the Lib Dems are more likely to be in another five years’ time.

Nic Cicutti can be contacted at nic@inspiredmoney.co.uk

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Comments

There are 8 comments at the moment, we would love to hear your opinion too.

  1. Nic, this is a very disappointing article. There are of course many flaws in the tax system and the set of reliefs given to pension contributions and pension commencement lump sums. But you have just thrown out a load of different ideas for pension reform which do not link together in any meaningful way. We have had so many changes to pensions over the last few years, so any further changes need to be thought out rather more carefully than you appear to have done. Being radical is not a good thing of itself, it is only good if the outcomes are better than what went before. There are so many disadvantages with a uniform rate of tax relief on contributions and the retrospective removal or capping of pension commencement lump sums is fundamentally unfair on all those who entered pension contracts expecting a 25% lump sum. So whilst there are reasons for changing things and being open minded surely you could have produced a more reasoned article which backs up what you are saying. This article seems to be provocative without bringing anything useful in the form of well thought-out ideas. So high on controversy but low on interest.

  2. What the article seems to be saying in its simplest form is that the wealthy should be paying more.

    At present in the UK just over 50% of the population are ‘takers’ from the state system, i.e. in net terms they get back more than they put in.

    Let’s cut to the chase and ask the question of whether that 50% figure is about right. Should it be more or less and if so how much should it be?

    Only then we will be in a position to discuss how it’s achieved through, for example, tinkering with the pension system as is being proposed here.

    There is a distinctly political vein that runs through this article predicated on socialist principles. The assumption that it’s unfair that the wealthy get all the tax breaks is fundamentally wrong. They get the breaks because they put a lot more into the system in the first place. They are the golden egg. Bash it too much and they might decide not to play and then everyone loses.

  3. @Grey area. We all have different political views. So we will all push our own agendas subliminally. I have to say that I do not consider there to be anything wrong with those who receive more being required to pay more tax. Clearly people should not all earn the same but those that earn more need to contribute more to society’s running costs than those who earn less. Otherwise society could not fund the public services that enable it to function effectively. And then no one would win.
    I believe that the way to collect tax from the wealthy is to tax income generated from pensions rather than the pension capital itself. If instead we go down the route of retrospectively taxing people on pension pots built up over many years then that is against any natural justice, regardless of whether the wealthy or the poorer lose out. Capital Gains Tax already enables society to tax gains on capital held outside a pension, and one of the principles behind tax relief on pensions is to encourage long term investment. This is a valuable source of capital for industry, particularly as pensions do not permit withdrawal from pensions until age 55.
    Having said that I do not personally have an issue with limiting tax free cash for funds built up from contributions made AFTER a change, but it would not be right to impose a blanket cap which would be levied on funds built up from contributions made BEFORE the introduction of a cap. That is retrospective and unfairly changes the goalposts after the event.

  4. Radical changes were attempted by Stalin, Hitler and later Pol Pot. Being radical doesn’t always mean progress.
    Pretty much, agree with Brian Gannon’s comments .

  5. @Brian Gannon
    My question was not about whether the wealthy should pay more. It was about how much they should pay. At the moment the split is 50/50 with half the population supporting the other half. Is that right or should it be more or less? Talking in general terms is easy. It gets a little more uncomfortable when you have to attach figures. I have no problem with your proposals but they are meaningless unless you have a target in mind. Should the top 30% support the other 70% for example? Fairness takes on a different dimension when you quantify it…

  6. @Greyarea
    As previously stated fairness is a matter of personal opinion. And the percentage of who is supported by whom depends very much on the disparity of wealth. For example if one person owned 99% of all assets then that one person should support the vast majority of all other people. If everyone had equal assets then no one should support anyone. Without access to the ONS figures on distribution of wealth your question is fairly meaningless.

  7. @Brian Gannon
    My question is an awkward one but not meaningless – ONS statistics on the subject are publicly available on their website.
    You might like to start with ‘Income and Wealth, Social Trends 41’ which provides a good summary and starting point.
    Makes for interesting reading. Distribution of income and wealth is not as skewed as some would like the rest to think.

  8. @Grey Area
    Thank you for the information – If I were retaking my Economics Degree I may well trouble myself to analyse these details. But as I am neither studying nor standing for Parliament I will content myself with sticking to policy principles rather than in-depth specifics. But thank you and I shall have a read of them at some point anyway.

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