Webb, who worked with the chancellor on pension strategy in the previous coalition government, believes Osborne favours the “pension Isa” plan over an alternative flat rate tax system, where all savers get the same level of tax relief on their pension contributions regardless of their income.
The key difference between the two schemes is over when tax is paid. With the so-called “pensions Isa”, savings are made from after-tax income and no tax is paid on the interest or the investment returns when it comes to drawing down the funds.
By contrast, with the current pension scheme no tax is paid upfront on contributions; the only tax due is paid at the end, when a saver starts to take the money out in retirement.
Disincentives abound
Since it was first mooted; Royal London, the largest mutual life, pensions and investment company in the UK, has consistently attacked the Isa-style pension proposal, believing it would turn people away from long-term savings over fears of double taxation.
“The “pensions Isa” is a series option and the logic of the Isa is there is there is no tax free lump sum in an Isa,” Webb told International Adviser.
“So if for example you’ve been planning to pay off your mortgage with your pension lump sum in 10 year’s time, guess what!,” he said.
Webb also noted in an article published by the Sunday Times that the low flat rate system of tax relief might raise a lot of money initially for the chancellor but could also put higher earners off pension saving altogether.”
In that article Webb added that while it was true of the pension Isa system that there would be no tax paid on funds when a saver retires, that would ultimately be up to a future chancellor.
“Osborne would be double dipping: benefiting both from the tax due on the pensions of today’s retired population as well as the tax due on the earnings of today’s workers, even though the latter are locking their money away in a pension,” he wrote.
One preference
Webb said he did not believe that the flat rate was ever going to be the Treasury’s first preference.
“Back in July 2015 when the chancellor published his green paper, the idea of a flat rate was not mentioned at all. Instead, in his budget speech, Osborne specifically floated an alternative idea, namely making saving for a pension more like saving in an Isa,” he said.
“To the chancellor, the big attraction of the “pensions Isa” is that he suddenly gets a tax windfall, he said.
Quiet extinction
“Under the current system you can get tax relief on your pension contributions, enjoy tax-free growth in your pension fund and then take a quarter out tax-free — a hugely tax-advantaged way of saving. In effect, a quarter of the money in your pension never gets taxed at all under the current rules,” Webb said.
“But with a pensions Isa, this tax break quietly disappears.”
“Given that the break costs the chancellor around £4bn per year in lost revenue, it is easy to see why he might like to get rid of it,” he said.
“It is remarkable to think that one of the most popular and best understood parts of the tax system — the tax-free lump sum — could be on the brink of extinction without anyone noticing,” Webb said.
