Budget tax swoop?
All eyes will be on Philip Hammond in the run-up to the Budget, especially those of higher earners looking to keep their pension tax breaks.
Few would disagree that saving for retirement should be encouraged, but there is a weight of opinion that says tax relief is not an effective or well-targeted way of incentivising saving into pensions.
Critics argue that the system favours the wealthy minority and fails to provide the necessary incentive to lower earners. Indeed, the bulk of tax relief given currently goes to higher rate taxpayers (over 50% to the richest 10% of the population1). And while the government has put some limits on how much can be claimed, it has yet to reform the actual rates at which higher earners can subsidise their pension savings.
The latest voice to weigh in on the debate is that of Liberal Democrat leader Vince Cable, who has labelled the current system “deeply regressive”. Mr Cable is calling for the introduction of a flat rate of tax relief, and a limit on the tax-free lump sum people can withdraw from their pension pots.
His proposals follow closely on the work of the Treasury Committee, which reached similar conclusions in its inquiry into household finances. Indeed, there was widespread scepticism among those who gave evidence to the committee about the effectiveness and fairness of tax relief in incentivising pension saving.
Baroness Altmann, the former pensions minister, told the committee: “Tax relief is poorly understood and poorly targeted…If you wanted to encourage lots of taxpayer spending to incentivise saving, the people you would normally most want to incentivise are those who have least ability to save. The way tax relief works, of course, it gives most incentive to those who are at the top end.”
Michelle Cracknell, the chief executive of The Pensions Advisory Service told the committee that, even among the relatively engaged pool of people that contact her organisation, tax relief and other benefits of pension saving are poorly understood.
There are even calls for the current system to be abolished. Michael Johnson of the Centre for Policy Studies added: “I would scrap all pensions tax relief, including employer NICs rebates. That creates a cash flow of about £46 billion a year. I would introduce a bonus structure that is an incentive disconnected from your tax-paying status.”
Another eye-catching recommendation from the Treasury Committee was the suggestion that the lifetime allowance be ditched and replaced with a lower annual allowance. Both allowances act in tandem to restrict tax-relievable contributions to a registered pension.
The annual allowance was originally set at £215,000 and the lifetime allowance was £1.5 million. Both have become less generous in recent years, with the annual allowance currently £40,000, and the lifetime allowance at £1.03 million. Additionally, the annual allowance has been tapered for high earners since 2016.
For Sir Steve Webb, the Minister of State for Pensions from 2010–15, the government should focus on a further reduction to the annual allowance and the abolition of the lifetime allowance, rather than “big-bang reform”.
“Instead of having an annual allowance, a tapered annual allowance, a lifetime allowance, have a simple, perhaps lower, if necessary, annual allowance. Having an annual allowance and a lifetime allowance seems odd; you are capped on the way in and on the way out, and the lifetime allowance is a cap on success,” he said.
John Glen, the Economic Secretary to the Treasury, has previously acknowledged the debate around further pension reform, but did not commit to going further.
He told the committee: “You are right to say that there are other ways of looking at this in terms of whether it should go further or whether it should be a flat rate…There is, however, also an issue around stability, and we have got to a place now where we are saving, I think, £6 billion from the changes that we have made and, arguably, a lot of that was going to subsidise wealthy people’s pensions.”
Thoughts now turn to the Budget on 29 October and, more specifically, those reliefs and exemptions that may come under threat. Given the political backdrop, and the government's wafer-thin working majority, a cut to higher-rate pension tax relief may be avoided. Nevertheless, money for the prime minister’s health, fuel and housing pledges must be found from somewhere. If latest reports are to be believed, the chancellor is examining a range of options, including a further reduction to the annual allowance.
Whatever happens, pension tax breaks for higher earners are unlikely to become more attractive. Therefore, pension savers would be wise to think about making the most of the existing allowances, so that they can benefit from the current rates of tax relief on their contributions, and to carry forward any unused allowances from the three previous tax years.
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1 HM Revenue & Customs, Personal incomes statistics 2015/16 (tables 3.3 and 3.8), 28 March 2018; and Treasury Committee staff calculations