Treasury officials will be working overtime in the next few weeks digesting the responses to the latest consultation on pension tax relief, which closed last week.
Chancellor George Osborne has asked whether today’s model of tax-free contributions and growth, then taxed pension income, is still the best way to encourage a healthy savings culture.
You can understand why he asks. Pension tax relief costs the exchequer £50bn a year in lost income tax and National Insurance. Two thirds of this money goes to support the pensions of the richest 10 per cent of society: the 40 per cent and 45 per cent taxpayers. In an age of austerity, these numbers probably make uncomfortable reading for the Chancellor.
Many also argue the current system is complex, with the value of tax relief opaque, especially to those in workplace pensions. Politicians want voters to appreciate it when public money is spent on their behalf and £50bn a year pays for a lot of new, and highly visible, nurses, schools and roads.
Ideas already suggested to the Government include a switch to flat rate of tax relief, say 30 per cent, or a system whereby you would contribute to a pension from taxed income and then that contribution is matched by the Government up to a certain level.
In proposing any new system, however, George Osborne needs to be very cautious of unintended consequences.
He has already taken big steps towards curbing the tax relief bill for top earners. The lifetime allowance has come down from £1.5m to £1.25m and falls again to £1m from next April. This has been combined with a cut in the annual allowance to £40,000. The Treasury says these steps will cut £6bn from the cost of tax relief. The tapered annual allowance from next April will go even further, restricting contributions to just £10,000 for the highest earners.
These steps alone have caused a pensions “pinch point” for some key groups of workers. Take hospital doctors and GPs: many of those with long service in the NHS are finding themselves in positions where their ability to accrue meaningful extra pensions is very limited. This, in turn, is causing them to reassess their position and look at their work life/balance.
Some are already planning to cut their NHS hours and substitute non-pensioned private work. Others, especially GPs who receive no employer payments into pension, are looking at early retirement, taking a reduced pension to avoid LTA issues. The net impact could be a significant exodus of experienced medics purely because of pension tax changes at a time when the NHS is under huge pressure.
Elsewhere, the Trades Union Congress warned at its conference last month that company executives are increasingly becoming disengaged from pensions, primarily because they can no longer benefit themselves.
Whitehall policymakers need to be cautious that any further overhaul of tax relief does not end up exacerbating the problem. For example, if they decide to introduce a flat rate relief at 30 per cent, is there still the need for a lifetime allowance? Probably not.
The Chancellor has shown he is prepared to listen and adapt in the past: a proposal last year to ban any transfer away from a defined benefit scheme was quickly reversed. His ears need to be wide open on this issue too.
Stephen Womack is a chartered financial planner at David Williams IFA