Pensions minister Steve Webb insists his proposal to introduce a flat-rate of tax relief is workable despite industry experts questioning how the reform would be implemented for defined-benefit schemes.
In an interview with Money Marketing last week, the Liberal Democrat MP said he is pushing his coalition colleagues – as well as his own party – to pursue bold tax relief reforms.
He said the current system is “skewed towards higher earners” and proposed an alternative whereby everyone would receive the same rate of tax relief, set between 20 per cent and 30 per cent.
However, a paper published by the Pensions Policy Institute last year warned it would be “difficult” to implement a single rate of pensions tax relief for DB schemes. This is because employer and employee contributions are paid into a common fund rather than into individual member accounts. A single rate would require the employer to calculate the deemed contribution for a larger number of employees.
Towers Watson senior consultant David Robbins says: “If the Government decides to follow through with this, there is a risk that it could get very messy.
“If you are in a DB scheme, the value of contributions the employer is paying is not supposed to reflect the value of accrual to the member. It is an average across the membership.
“If the Government decides to press ahead with a ban on DB-to-DC transfers, you might start thinking about separate tax regimes for DB and DC to overcome these difficulties.”
Rowley Turton director Scott Gallacher says: “This would be incredibly complicated to implement for both DB and DC schemes. Adjusting employee contributions should be relatively straightforward but it is not clear how it would work from an employer perspective.”
Webb acknowledged that his proposals would not be straightforward to implement but he said: “About a third of all tax relief is delivered by people paying out of their net pay and then HMRC writes a cheque to top it up. That is how Nest does tax relief, for example.
“That could apply to DB as well. Schemes would have to juggle their contribution rates or accrual rates to offset that but I think it is doable.”
Webb also suggested that similar changes would need to be brought in for employers to prevent people using salary sacrifice to lower their pensions tax bill.
He said: “Clearly, you do not want a flat rate of relief on the employee side, everyone shovelling contributions through the employer and suddenly getting 40 per cent again.
“So you would have to have an equivalent matching measure for the employer side.
“There are complexities that would have to be addressed and there is no point pretending that is not the case. We need to redress the balance of tax relief and having looked at it, there is a lot to be said for more radical reform than is our current policy. But I have to persuade my own party first.”
Webb’s tax relief reform proposal – the DB problem explained
In a defined benefit scheme, contributions are paid by the employer and employee into a common fund, which is invested to provide all retirement benefits.
The deemed contribution is an estimate of the increase in the individual’s defined benefit pension entitlement in the previous year. In the current system, unless there is a risk of the deemed contribution for an individual exceeding the annual allowance, the deemed contribution is not calculated.
A single rate would require the employer to calculate the deemed contribution for a larger number of employees.
As the deemed contribution is based on the increase in value of the fund, the deemed contribution and the extra tax may not bear any resemblance to the employer’s and employee’s contributions made on behalf of that employee.
As such, this system may not appear transparent to pension savers, and could reduce the attractiveness of pension saving to employers and employees if they face higher income tax payments and more complexity.
Source: The Pensions Policy Institute