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Steve Webb urges bold pension tax relief reform with flat-rate below 30%

Pensions tax relief reform is set to become a key battleground ahead of next year’s general election, with Liberal Democrat pensions minister Steve Webb pushing for radical changes that would see the introduction of a flat-rate set below 30 per cent.

Last month, the Centre for Policy Studies published an explosive report that reignited the debate over the future of pensions tax relief.

The CPS policy paper argues that the current system – where contributions and investment growth are tax-free but retirement income is taxed – is unfairly skewed in favour of the wealthy.

The think-tank says tax relief should be scrapped altogether and replaced by a Treasury contribution of 50p per £1 saved. This would be subject to an annual allowance of £8,000, with prior years’ unused allowance permitted to be rolled up over a period of up to 10 years.

Webb agrees the current system is unfair and is pressing his coalition colleagues – as well as his own party – to pursue bold reforms.

Speaking to Money Marketing, Webb says: “We know the cost of pensions tax relief is a very large number and the benefits are heavily skewed towards high earners.

“If you are looking for a way to help the average pension saver in a world where you want to reduce the budget deficit in a way that is progressive, pensions tax relief is an obvious place to look. The goal would be to have a structure in place that was stable. People keep saying to me ‘don’t keep fiddling’ but as long as we fail to address the unfairness of the current structure people will go on fiddling.”

Tax relief set for radical reform?

Encouraging people to save into a pension through tax incentives cost the Treasury £54bn in 2012/13, according to the CPS.

While the official LibDem position is to cut the lifetime allowance from £1.25m to £1m, Webb wants the party to campaign for a fundamental overhaul of the system that would see the overall spend on pensions tax relief reduced.

“My proposition would be that you would have a flat-rate of relief that would be bigger than the current standard rate and lower than the current higher rate,” he says.

At-a-glance tax relief reform 150514

“I anticipate in the real world a government will be wanting to spend less rather than more on pensions tax relief. The Pensions Policy Institute reckons 30 per cent is the breakeven figure, which just shows you how skewed it is towards the higher earners. So I suspect you would be talking about a standard rate north of 20 per cent but south of 30 per cent.”

Webb suggests this reform could be coupled with the abolition of the lifetime allowance.

The LibDem MP’s proposal has been backed by an unlikely source – Royal London chief executive Phil Loney.

“Pensions tax relief needs reforming,” he says.

“You won’t hear me say this too often but I agree with Steve Webb – I think we should have a flat rate of tax relief and I also like the fact he has been speculating about removing the lifetime allowance.

“That is absolutely the right dir-ection of travel. A flat rate would actually support auto-enrolment because the real focus of these reforms is people who are paying lower tax rates.”

‘Utter nonsense’

Labour has previously said it will restrict higher-rate relief for people earning over £150,000 from 45p to 20p in order to fund a compulsory jobs guarantee for the under 25s.

With less than a year to go until the general election, this remains the party’s position.

Shadow pensions minister Gregg McClymont says: “Labour has been clear that we need a fair pensions system which builds income for all savers in retirement.

“We have said that we will restrict pensions tax relief for the very highest earners in order to pay for Labour’s compulsory jobs guarantee for young people.”

Webb describes Labour’s policy as “utter nonsense”.

He adds: “This is pure tokenism. If you are a serious, progressive political party and you think the only people who get too much tax relief are on £150,000 or more, then you do not know what the word progressive means.”

“If you are looking for a way to help the average pension saver, then tax relief is an obvious place to look.”

The Conservatives have yet to set out their views on pensions tax relief although Treasury select committee chairman Andrew Tyrie has recently urged the Government to create a single tax regime for all savings and pensions vehicles.

He says: “There may be scope in the long term for bringing the tax treatment of savings and pensions together to create a ‘single savings’ vehicle that can be used—with additions and withdrawals—throughout working life and retirement. This would be a great prize.”

A Conservative party source would not confirm the party’s position in the run-up to the election but says: “The Prime Minister has been clear that he is a low-tax Conservative.”

The Treasury, led by Conservative Chancellor George Osborne, says the fairest way to reduce the cost of tax relief is through the existing annual and lifetime allowance mechanisms.

A Treasury spokeswoman says: “Pensions tax relief provides strong incentives for everyone to save; however this needs to be balanced against the need to protect the public finances from the growing cost of pensions tax relief.

“We believe the fairest way to restrict this is to limit the amount of pension savings an individual can receive relief on.

“Although the Government keeps all taxes under review, there are no plans to make any changes to pensions tax relief.”

Complexities

While introducing a single flat rate of tax relief may create a simpler system for employees to understand, experts warn the reform could create problems for employers.

Pensions Policy Institute director Chris Curry says: “Operating tax relief at the marginal rate is relatively straightforward for employers to do. Using a different rate would mean changes for payroll systems.

“And there are additional difficulties for employers with defined benefit schemes who would need to calculate ‘deemed’ contributions for every member and where extra payments would need to be made either to or from every employee, depending on their marginal tax rate.”

Rowley Turton director Scott Gallacher agrees.

He says: “This feels like another fundamental attack on pensions and I cannot see how they can implement it from an employer perspective. A single flat-rate of tax relief would inevitably be incredibly complicated to implement and could destroy the incentives for wealthier individuals to save.”

Despite the inherent difficulties of reforming the pensions tax system, a political consensus is beginning to form that the current rules need recalibrating. But deciding how and when that should be done looks set to divide the major parties ahead of next year’s general election.

Tune in to MMWired from 10.30am on Friday 16 May to watch leading industry experts debate the Budget pension reforms.

Expert view

Kenny-Mel-Radcliffe and Newlands peach.jpg

Mel Kenny, chartered financial planner, Radcliffe & Newlands

“I am in favour of introducing a flat-rate of tax relief because it would encourage lower earners to save and it would be simpler to understand. Labour’s idea looks like something Gordon Brown would have come up with and risks creating huge complexity.”

Expert view

Tom McPhail, head of pensions research, Hargreaves Lansdown

Tom McPhail, Hargreaves Lansdown
 

“Reform of pensions tax relief now looks inevitable because there is an overriding perception that the current system is unfair. The lifetime allowance is a policy measure that has reached the end of its life span and needs to be abolished.”

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Comments

There are 20 comments at the moment, we would love to hear your opinion too.

  1. Why do ‘wealthy individuals’ need incentives to save?

    Surely the best incentive for anyone to save is the message ‘you will be poor in retirement if you don’t’.

    If the fear is that ‘wealthy individual’s’ will take their savings elsewhere without their mouths being stuffed with tax relief gold, then let them – it’ll leave more of the HMRC largesse for those that genuinely need it.

  2. “People keep saying to me ‘don’t keep fiddling’ but as long as we fail to address the unfairness of the current structure people will go on fiddling.”

    Top logic. We can’t not fiddle because if we don’t fiddle we’ll have to fiddle? Ladies and gentleman, I present the career politician. Here we see what happens when we divorce a man’s mouth from his capacity to reason.

    Of course the benefits of pension tax relief are skewed towards high earners. They’re the ones with money to save! And people who have the discipline to save are more likely to have money. Oh, what’s the point. It’s like trying to reason with a wasp.

  3. Brilliant, so we’ll have to introduce ant-forestalling provisions again because the first thing I would do is advise clients to use salary sacrifice. In fact for basic rate tax-payers it’s better than a flat 30% anyway!

  4. Gavin Fielding 14th May 2014 at 11:58 am

    Policy will be decided by what generates the most money with the least squealing from the voter.

    Looking back to when I started work, and couldn’t afford a pension basic rate tax was 30%, and the higher rate on an inflation adjusted basis would kick in at nearer £50,000 today. Yet the 40% higher rate now comes in at £32,000 catching teachers, nurses, office workers, hardly the very wealthy.

    Donl;t even get me going on ‘fiddling’ does he mean in the messing about sense of fraud sense?

  5. A flat rate of tax-relief is very sensible but I would like to see, or prefer to see, an NIC reduction related to pension savings, both for employees and employers. That would favour “average” earners far more than high earners, it would also help to reduce the cost burden of NICs for employees and employers which, in particular, will help small to medium sized businesses who find the “tax on jobs” unnecessarily expensive. Steve Webb I’m still waiting for your call if you’d like to talk through the detail.

  6. Hyman Wolanski 14th May 2014 at 3:45 pm

    Focussing on the current cost of tax relief on pension contributions is misleading since it misses the obvious point that income tax is ultimately paid on the pensions relating to those contributions.

    And, in any case, the easiest way to reduce the tax relief on the pension contributions paid by high earners is to reduce the rate of income tax on high earners.

  7. The man is determined to ensure that the total amount going to pensions will be decimated. (He should care – his party won’t be able to fill a phone box after the election) It isn’t the basic rate payers that fund the most. The pension companies will have their legs cut from under them.
    As has already been mentioned, it doesn’t seem to occur to these numpties that the better off pay the most tax anyway. The tax relief they get on pensions is only a ‘loan’ as they will pay tax on the income when they finally get it. This receipt will now be severely curtailed.

    What will the better off do now? Max out their ISAs at £30k for husband and wife. Then do VCTs and then insurance bonds. Until some venal Government starts chopping the rules again. This will ultimately result in the better off saying “Stuff you lot – I’m off” and we will have the sort of brain drain we had in the Wilson era. They just don’t look across the Channel and see what Hollande has done in France.
    The answer is to vote to stay in Europe – hope that we have a United States of Europe run by Germany. We can’t do any worse and might just end up better. Our lot have shown over the last 40 years (with the exception of Maggie) that they couldn’t arrange a party in a brewery.

  8. Ridiculous, to view tax relief through the lens of “how money can be saved for our pet project” rather than “how can we get people to save for their old age”. Not withstanding the fact a Labour, or any other party’s “Job Guarantee for the under 25s” is a lie. Governments cannot create employment for the unemployed as the money they have comes from the productive part of the economy and the jobs rely upon work being created for them to do, it would lower the productivity of the UK even further, if that is possible.
    The reason tax relief is provided mainly to those who pay the most tax is simply a function of tax relief. Doubtless if the rate of higher rate tax went to 45% the wailings would be greater due to more “avoidance” (or completely legal tax mitigation to give it the real name). On that basis a 98% tax rate would mean “even more to the fat cats” if they paid into a pension (or were allowed to). It is constant amendment of the position each time someone gets into power which has undermined trust of pensions. Well that, together with increasing life expectancy (a good thing) and lower government borrowing and inflation rates (two other good things). This is why pensions no longer yield the 13% they once did. From this problem we have managed to create another where BTLs are the favoured route of many for pensions pushing up the price of housing for everyone (and those without an owned house need more money from pensions to pay rent)

  9. All employed higher rate taxpayers will change to salary sacrifice so the Govt loses the 15% or so of NI as well as income tax at the full marginal rate tax.

    So, they will have to abolish salary sacrifice arrangements – but what if new employees have a contract that is already adjusted etc…

    Are they going to find a way of restricting corporation tax relief to company contributions – too many schemes are underfunded as it is.

    There are so many unintended consequences here. Dear Mr Webb just leave it alone.

  10. Christine Brightwell 19th May 2014 at 12:01 pm

    Aaaaaaaaaaaaaagh. We have just had a budget full of radical changes. Before this government start planning more lets get what we have bedded in, take a deep breath and a more measured approach.

    A chef speaking on radio 4 said recently, it’s ok to have the ideas and the voice in your head telling you what you could do, just don’t let the voice come out of the big hole in the the front of your face – in this case, until you have thought the idea through properly and sought proper advice.

  11. Julian Stevens 20th May 2014 at 10:18 pm

    I disagree totally that the present long-standing system is skewed in favour of high earners. Why shouldn’t they receive tax relief on contributions to an approved pension plan that would otherwise be subject to tax at their highest marginal rate? By the same token, one might argue that the system is skewed in favour of zero earners, whose pension contributions up to £3,600 gross p.a. receive the benefit of relief at basic rate that they otherwise wouldn’t have to pay at all. Why should they get it?

    As far as I’m concerned, Webb is a prize prat who just keeps on coming out with stupid proposals that do nothing but damage to the idea of saving for retirement.

  12. Julian Stevens 21st May 2014 at 10:14 am

    A Treasury spokeswoman says: “Pensions tax relief provides strong incentives for everyone to save; however this needs to be balanced against the need to protect the public finances from the growing cost of pensions tax relief”. Hmmm, let’s consider that.

    1. Tax relief on contributions is just one incentive, not incentives.

    2. As if the relentless decline in annuity rates (not the government’s fault) weren’t on its own bad enough, 25 years of Treasury meddling, tinkering, interfering and generally buggering about with the pensions framework has severely undermined that incentive. Public trust in the whole system has been shot to pieces. That’s fact, not opinion.

    3. Given that fewer and fewer people are contributing to a pension plan, how are the costs of pension tax relief growing other than in direct proportion to increasing earnings? Is there any hard data to back up this claim or is it just a waffly sound-bite?

    4. What about the relentless reductions to how much people are allowed to put into their pension funds in any given tax year?

    5. What about the relentless reductions to the LTA? Pension savers (admittedly at the top end) are being squeezed in at both ends of the accumulation process and they jolly well don’t like it.

    6. What about the significant benefit to the central exchequer as a result of the removal of the facility for pension funds to reclaim the 10% deducted at source on share dividends? That could be repealed.

    7. What about the omni-present rumblings about the possible removal of the 25% TFC at retirement facility? Why doesn’t the government issue an unequivocal statement that this ~ specifically ~ will NOT be removed or modified?

    A statement from the Treasury such as this simply doesn’t hold water, added to which we have a pensions minister whose constant stream of stupid and confidence-damaging utterances render him virtually a loose cannon on deck.

    With all due respect to Tom McPhail, I would question his assertion that there’s an overriding perception that the current system is unfair. Is he suggesting that basic rate tax payers feel they ought to be granted tax relief at a higher rate than the basic one? With what justification? From where will the difference come? Or is there some great unspoken groundswell of opinion amongst higher rate tax payers that the present system affords them an unfair advantage and that the government really ought to address this by cutting their tax relief so as to give more than basic rate relief to basic rate tax payers? I hardly think so.

    I’ve certainly never encountered such opinions from any of my clients in any tax bracket and nor do I know anyone else who ever has.

    As said Henry Thoreau: Our lives are frittered away in detail. Simplify, simplify.

  13. Gavin Fielding 21st May 2014 at 3:28 pm

    Good comments Julian, I think it was Tony Hazell who said Gordons tax traid had deprived Pension schemes of £230 billion of growth since 1997. The real mess is in the tax system, with a poorly thought out mish mash of thresholds and allowances. One of the reasons pension tax relief is going up is because the proportion of total tax taken through income tax has gone up and is due to rise further.

  14. Gavin Fielding 21st May 2014 at 3:50 pm

    Good post Julian, I think Tony Hazell calculated the Gordon Brown tax raid has deprived pension schemes of £230bn of investment returns so far. Whats in a real mess is the tax system, the levels of relief and thresholds make no sense. As a percentage of total tax the amount taken through income tax is rising and expected to rise further, the laws of correlation decree that pension income tax relief will also rise.

  15. Julian Stevens 28th May 2014 at 10:02 am

    And another thing ~ what Cost:Benefit Analysis has been undertaken to validate, or at least vaguely justify, this latest idea?

  16. Julian Stevens 28th May 2014 at 10:19 pm

    The only (arguable) imbalance in the present system is for those who secure tax relief on their contributions at higher rate (during their working lives) whilst, depending on their assessable income in retirement, they might have to pay only basic rate tax on their (eventual) withdrawals. This, though, does not constitute a ‘skewed’ system, because those who are still HRT payers in retirement will still be subject to HRT on their eventual pension withdrawals.

    This, admittedly, is something of a conundrum but will not be solved by granting basic rate tax payers relief on their contributions at more than their marginal rate, with their eventual withdrawals being subject only to basic rate income tax. Such a system would, I suggest, constitute skewing in favour of basic rate tax payers quite specifically at the expense of HRT payers and would also cost the Exchequer more than does the current structure.

    Is there any evidence that it would:-

    1. encourage basic rate tax payers to contribute MORE to their retirement funds (bearing in mind that it would have no impact on affordability), or that it would

    2. NOT encourage higher rate tax payers to contribute LESS?

    Without first establishing these probabilities as firmly as is reasonably possible, any analysis of Costs (to the Exchequer) vs. Benefits (in terms of more people contributing more to their pension funds) would surely fall flat on its face. Apart from that, can the Exchequer reasonably afford to offer the majority of the population tax relief on their retirement contributions at a rate enhanced by perhaps as much as 50%?

  17. Who cares what Mr Webb says anyway? Following the showing in the latest elections he is pretty unlikely to be in Westminster after next May. What we have to really worry about is some numpty from the Labour party trying to ‘fix’ pensions. We have all seen where that leads!

  18. Alasdair MacDougall 5th June 2014 at 2:18 pm

    Does anyone else look back fondly on the Pre A Day world, when we had pre-87, 87-89 and post-89 regimes, carry forward & carry back, earnings cap and age related rules for contributions?

    We also had no penalties or charges for having “too much” in our pension pots.

    I wish the Tories would have the resolve and the nerve to say, “contributions to pension will be tax neutral and Annual Allowances & Lifetime Allowances will be broadly in line with what the earnings cap would have been”.

    That way, we’d be able to make realistic and tax incentivised contributions and be able to build up appropriate funds to provide a decent income. Add this to the proposed unlimited access via drawdown next April and we’re getting somewhere.

  19. Look when it boils down to it (and if you take the whole picture – which journalists seldom do) you can see that whole bunch of them in Westminster and not only inept, but colossal liars to boot.

    If they were really that concerned about retirement incomes, the first and most logical thing to do would be to reverse Gordon Brown’s tax grab. As Andy Newman has pointed out this is worth around £230 billion according to reports. A bit of a cap on charges and fees and Bob’s your Uncle.

    But no – we have this new wizard idea of pooled pensions – this should net the buggers a good bit in dividend tax as of course will AE. The wonderful idea of letting people access their pots will also accelerate the tax trawl and then of course there will be the extra hit to benefits a few years down the line. Boy George’s plan is to bribe the foolish now and lumber the next Labour Government (When they get in).

    Up the Revolution Bruvers!

  20. Julian Stevens 2nd July 2014 at 12:11 pm

    What’s the difference between tax relief and a Treasury contribution of 50p per £1 saved? It’ll all have to come from the same place.

    And if tax relief is cut for higher rate tax payers, the inevitable result will be an upsurge in undeclared salary sacrifice arrangements. Okay, Mr HRT, you can have either a salary of £60,000 p.a. with no pension contributions or a salary of £50,000 p.a. with a pension contribution of £10,000 p.a. (plus uplift for what we’ll be saving on NIC). That’ll be a private and therefore un-policeable arrangement between employer and employee.

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