The government’s attempts to source billions of pounds in spending by altering pensions taxation are unlikely to be successful, although the Autumn Budget is unlikely to produce major announcements in this area, experts have said.
Speaking at the Pensions and Lifetime Savings Association’s annual conference, Laura Myers, PLSA board member and head of defined contribution at LCP, explained that none of the most commonly cited options for pensions tax relief reform meet the five criteria set out by the industry body.
Any reform should promote adequacy, encourage the right behaviours, be fair, be simple to adopt and administer, and be enduring and sustainable. The current system meets three of the five criteria, but none of the possible alternatives meets more than two, she noted.
Moving to a single rate of 25 or 30 per cent, for example, would promote adequacy and encourage the right behaviours, but would not be simple to adopt and administer.
I think that there’s a lot of discussion that we need to have to think about what is it we’re actually trying to achieve by taking £5bn out of the system, and even prior to that, what is it that we think the whole pensions system is actually trying to achieve in itself
Chris Curry, PPI
Reducing the lifetime allowance and the annual allowance would be simple to adopt and administer and would be enduring and sustainable, but meets no other criteria. The same is true of removing national insurance relief on employer contributions.
The rest of the options, such as splitting the defined benefit and DC regimes, a single rate of 20 per cent, or capping the tax-free lump sum at £75,000, either only meet one of the objectives or — in the case of a tax-exempt-exempt treatment — meet none.
“It’s hard because, quite frankly, you wouldn’t start from here. You end up looking at the least worst situation on radical reform,” Myers said.
“And then, when you delve into the actual numbers on potential benefits for some groups, the amount that the government could generate, those figures are really uninspiring.”
In the case of a flat 25 per cent rate, for example, the government would only generate £0.6bn of the £5bn it would be looking to raise, and that is before tax relief is decoupled from income tax, she explained.
“So on balance, it’s the existing system that we support that matches our criteria the most closely. We know that’s not perfect, but really it does cause the least harm,” she said.
Pensions taxation can be overly generous
Carl Emmerson, deputy director of the Institute for Fiscal Studies, argued that there are areas in which the existing pensions taxation regime is too generous, and from which the government might look to source more money.
“There’s very much to commend the system that’s built around the idea that what you put into a pension is free of tax at that point. When returns accrue on a pension, there's no tax being levied on those returns — and that when you take money out of a pension, that is taxed. That sort of system would have many advantages,” he said.
“It would allow people to smooth their incomes over their lifetime, so it would mean that our income tax system wouldn’t be unduly harsh on people who have happened to have had elevated incomes in some periods of their life.
“It would actually tax more heavily those who end up getting higher returns, so if you get a really good return on your pension through law through skill, lots of effort, the state would tax you on that in the end when you get a higher pension income,” Emmerson continued.
He argued that there are three areas where the existing regime is too generous, and where changes might be made. The 25 per cent tax-free lump sum, for example, is not “that well targeted”, and placing a cap on it “would make more sense than putting a tap on the total amount of pension pot that you can accumulate, and it would make a lot more sense than putting an annual limit on how much you can put into a pension”.
Making employer contributions exempt from national insurance is likewise “extremely generous” and is benefiting from unintended subsidies from the raising of national insurance rates and the cutting of income tax, he said.
“We saw that the announcement of the new health and social care levy is going to continue that trend. If your employer puts money into a pension on your behalf, it will escape that levy on the way in, and that levy is not being paid on pension income in retirement,” Emmerson explained.
“So I think there is a strong case for some national insurance contributions being levied either on employer pension contributions, or on pension income in receipt, and there is lots of revenue at stake here.”
He added that the final area where the existing regime is overly generous is pension pots that are bequeathed, which is “indefensibly generous” and turns pension pots into vehicles for inheritance, not retirement savings.
No change expected in the budget
Chris Curry, director of the Pensions Policy Institute, questioned whether it was even desirable to try and source £5bn from the pensions system.
He said: “There’s always decisions to be made. There’s always advantages and disadvantages to certain options. There’s always winners, and there’s always losers. But to my mind, if you're trying to take £5bn out of the system, it’s very hard to create winners in that particular sense and all you’re going to do is create losers.
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“So I think that there’s a lot of discussion that we need to have to think about what is it we’re actually trying to achieve by taking £5bn out of the system, and even prior to that, what is it that we think the whole pensions system is actually trying to achieve in itself.”
The government’s temporary suspension of the triple lock reopened questions about the long-term sustainability of the system, and the suspension itself — or something like it — might turn out to be a long-term solution, he added.
Myers suggested that, especially in light of recent moves such as the social care levy, “we are probably a little bit less likely to see another radical announcement on tax from the government. Maybe pensions is not going to be the place where we’re going to see huge radical reform”.
