UK government plans for further pension tax reform could remove tax advantages for savers, says expert

Out-Law News | 10 Jul 2015 | 10:41 am | 3 min. read

Changing the way in which pension saving is taxed to make the system "more like ISAs" would remove some of the tax advantages that encourage people to save towards retirement in the first place, an expert has said.

Moving towards a system in which pension contributions were paid in from taxed income and then withdrawn tax free would "effectively remove the tax advantages of the tax free lump sum", while speeding up the UK government's tax receipts, said Alastair Meeks of Pinsent Masons, the law firm behind Out-Law.com. It would also "take higher rate tax relief away from all higher rate taxpayers but only give tax relief at that rate to those of them whose pensions would also be taxed at the higher rate", he said.

"Perhaps none of these have crossed George Osborne's mind, but it does seem like a happy coincidence that this is being floated in an austerity budget," he said.

"Separately, the European Insurance and Occupational Pensions Authority only just on 7 July 2015 published a consultation paper on the creation of a standardised pan-European personal pension product. As it noted, this project becomes more tricky where different countries within the EU tax pension savings and benefits in different ways. A proposal of this type would make reaching agreement on a common way forward harder, not easier," he said.

The government has asked "individuals, consumer groups and employers", as well as providers, to respond to a 'green paper' on potential changes by the end of September. Once they have done so, it will publish a summary of responses and set out whether it intends to press ahead with further change or maintain the current system, it said.

Speaking ahead of the publication of the Summer Budget, the chancellor said that the proposals needed "careful and public consideration" and that the government did not intend to "pre-judge the answer".

"Our pension reforms have given huge freedom to people who've worked hard and saved hard all their lives - and many thousands are, with the free guidance service we offer, making use of those freedoms to access their savings instead of buying annuities," he said. "Now it's time we looked at the other end of the age scale – at those starting to save for a pension."

"Our goal is clear: we want to move from an economy built on debt to an economy built on the more secure and productive foundations of saving and long-term investment," he said.

Currently, pension contributions by both individuals and their employers are made free of tax at the point that they are paid into pension schemes, subject to an annual and lifetime allowance. Employers are also exempt from national insurance contributions (NICs) on workplace pension contributions. Any growth in the value of those pension contributions is also free of tax, subject to the lifetime allowance. Pensions in payment are taxed as income, but individuals can take up to 25% of their savings as a tax-free lump sum on retirement.

Among the proposals put forward by the government in its paper is the introduction of a 'taxed-exempt-exempt' system, under which contributions would be made from taxed income but investment growth and the payment of benefits would be free of tax. The government could also "top up" contributions by an unspecified amount before the individual reaches retirement. It is also seeking views on "less radical" changes, such as retaining the current system and altering the lifetime and annual allowances, according to the paper.

At the Summer Budget, Osborne announced changes to pension tax relief for the highest earners, to come into force next year. The annual allowance of £40,000 will be "tapered away" by 50p for every £1 that an individual earns over £150,000; ultimately falling to a minimum of £10,000 for those earning over £210,000. The change will fund a more generous inheritance tax (IHT) allowance of up to £175,000 per person on family homes.

"The hit on pensions exceeds the cost of the IHT giveaway by quite some margin – in fact, the manoeuvre results in a gain to the Exchequer of £2.4 billion," said pensions expert Simon Laight of Pinsent Masons. "The question now being asked is whether trust in pensions has just got better. Many think not, saying stealth manoeuvres like this diminish trust and damage the incentive to save."

"People understand ISAs. The tax incentive is clear and simple to understand. If clear and simple incentives are needed to encourage people to save for their retirement, as suggested by the government's consultation paper, perhaps pensions should be converted to the ISAs tax system - however, that argument ignores the truth that clear and simple doesn't necessarily equate with better," he said.