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.
“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.”
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.”
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.
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.”
Tom McPhail, head of pensions research, 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.”