There has been speculation that UK chancellor Sajid Javid is considering a reform of the pension taxation system in his upcoming March 2020 budget.
According to AJ Bell senior analyst, Tom Selby, barely a single budget goes by that the Treasury isn’t rumoured to be pondering a radical pension tax relief reform.
But he believes uncertainty will see investors as the main victims.
“This constant speculation risks altering investor behaviour and damaging confidence in the stability of the system,” Selby added.
“Ironically, in the short-term, such stories will inevitably cost the Exchequer cash as savers pile into pensions to make the most of tax relief while it is still there.”
The latest rumour coming out of 11 Downing Street is a potential 20% cut to pension tax relief.
Looking back
This was a move already eyed by former chancellor George Osborne in 2015.
But what would a tax relief cut mean?
“Currently individuals receive tax relief at their highest marginal income tax rate on their personal contributions,” said Steven Cameron, pensions director at Aegon.
“So, moving to a flat rate, somewhere between basic and higher income tax rates, would be good news for non-taxpayers and basic rate taxpayers, while higher and additional rate taxpayers would see their government top-ups reduced.
“In terms of simple appeal, a flat rate relief of 33% would see the government add £1 for every £2 from individuals.
“But, if set below 30%, higher rate tax payers expecting to pay higher rate tax in retirement might find pension saving unattractive, undermining the success of automatic enrolment, which ‘works’ because pension saving is in virtually everyone’s interest.
“Simply removing higher rate relief, and granting 20% relief to everyone, would not affect basic rate pension savers, but would severely dent the attractions for higher rate taxpayers many of whom are far from ‘wealthy’,” he added.
International Adviser recently reported that higher and additional rate tax payers fail to claim around £850m ($1.09bn, €1bn) a year in pension tax relief, because of how complex the system is to navigate.
Too difficult to pull off?
A pension tax relief reform was discarded in 2015 because of the many difficulties that would need to be addressed.
“The three biggest areas of complexity relate to the tax treatment of employer contributions, how to avoid a ‘salary sacrifice loophole’, and how to apply such an approach to defined benefit schemes,” Cameron said.
“Rushing to cut pensions tax relief could do long term damage to UK retirement savings, so we urge the chancellor and his team to avoid going too far, too fast, and instead to engage with the industry to resolve issues.
“We also recommend testing any new approach with savers to understand how it might change retirement savings behaviours,” he added.
Fiona Tait, technical director at Intelligent Pensions, shares Cameron’s sentiment, claiming the UK Government should take the time to consider the effects of the measure and not just “leap to a simple conclusion”.
She said: “While I can certainly see the attraction of a single flat rate of pension tax relief, 20% is at the lower end of range of reliefs discussed in previous consultations, which would mean far less money would enter into the pension system as a whole.
“I would suggest that some proper modelling is carried out to assess whether 20% is, in fact, the most suitable rate or just convenient for a government who wants to keep the cost of tax relief to a minimum.
“We have already seen just how badly wrong that can go with the tapered annual allowance. A flat rate of 20% might make the change easier to manage workplace schemes where pension contributions are deducted from pre-tax earnings, but it doesn’t address the issues that would be faced by final salary schemes where funding levels could be heavily impacted,” Tait added.
Don’t discourage saving
Jon Greer, head of retirement policy at Quilter, argues there may be a need for a cross-party independent commission to make sure the government gets it right.
“A move to a single rate of tax relief would be a bold move, however, any kind of reform needs careful thought and should not just be a political play,” he said.
“Moving to a flat rate system could easily be presented as a re-distributive measure aimed at boosting the pensions of lower earners, funded by slashing the pension tax break for those on higher incomes.
“But it could be a false economy if it discourages overall levels of pension saving and damages the fundamental principle that pension saving is effectively free of income tax.
“There is a strong case for the government to establish a cross-party independent commission given the ripple effects caused by changes to pensions policy.
“This would be a change that would affect every saver and worker in the country. The government can’t afford to make mistakes when it comes to retirement savings, particularly if they are serious about building a healthy and sustainable savings culture.
“However, the likelihood of this occurring is slim, since the Treasury is unlikely to give up responsibility for such a large part of government spending to an independent commission, regardless of how logical the arguments for it are,” Greer added.
Beyond tax relief
AJ Bell’s Selby said that there are other areas the government should consider changing, and it should not stop at pension tax relief.
“The annual allowance, for example, has become ridiculously complex, with three different versions for people to navigate,” Selby said.
“Moving to a single annual allowance for defined contribution (DC) savings would represent a significant positive step in simplifying pensions. There should then be an evaluation of whether the annual allowance is an appropriate mechanism for controlling defined benefit (DB) pension costs given the problems it has caused.
“One option worth considering, and flagged previously by the Office of Tax Simplification, would be to control DC pensions with a single annual allowance and DB with a lifetime allowance.
“This would radically simplify the rules and remove the unfair punishment against strong investment performance causes by the lifetime allowance in DC pensions.
“Beyond this, there now needs to be an acknowledgement that the lack of clarity about the future of pension tax relief – and the rumour and speculation this causes – needs to be addressed.
“Savers should be confident the product they commit their hard-earned cash to for decades won’t be subject to constant change.
“If there is to be further reform to pensions taxation, we urge the government to take a genuinely long-term approach by committing not to make further changes for at least 10 years,” he added.
