A silk purse for pensioners

The problem is that the damaging measures are definitely happening, whilst the beneficial reforms are little more than a glimmer in the chancellor’s eye. The challenge is to make sure that we do not miss this opportunity to turn a sow’s ear into a silk purse.

The short-term changes, which take effect from April 2016, are the restriction of the lifetime allowance to £1m and the tapering of the annual allowance for those with incomes between £150,000 and £210,000.

The problems with the lifetime allowance are well-known, and the reduction to £1m will simply make matters worse. There will need to be another complex tier of transitional arrangements, and the system will continue to be based on pension outcomes rather than pension inputs, thus penalising those who invest their money well.

But the far worse change is the tapering of the annual allowance.

Reducing the tax breaks of high earners sounds like a no-brainer. The Treasury’s own figures show that two-thirds of all pension tax relief goes to the small minority of the population who pay tax at the higher (40 per cent) or additional (45 per cent) rate, so surely this money could be better spent.

But the way that the government has chosen to go about it adds mind-numbing complexity to the system and – even more importantly – risks a profound disengagement between Britain’s senior managers and the pensions of their workers.

The complexity comes from the fact that your annual allowance for any given year will depend on your ‘adjusted income’ for that year – something you cannot know at the start of the year. Adjusted income includes your gross earnings and other taxable income, as well as the value of your employer’s pension contributions.

Many people will not know if they will be within the scope of the taper at the start of the year, notably the self-employed and those whose remuneration includes a significant bonus element. So how are they supposed to decide how much they can put into a pension? And the complexity for DC savers is as nothing for the new arrangements for people with DB pension rights.

But complexity may not be the worst feature of the new system. The real damage could come if top and middle managers decide to do minimal pension saving or even give up on pension saving altogether. The tapering of the annual allowance will make many more managers question whether pension saving is worth the complexity and uncertainty.

And if senior management have no personal engagement in the workplace pension scheme, how can we have any confidence that the quality of such schemes will not steadily decline?

Just at the point that automatic enrolment has got over 5m workers into pension savings for the first time, it is incredible that the government should bring in a measure which will lead those who take the key decisions about pensions to have little personal interest in the subject.

But there is light at the end of the tunnel.

It comes in a Treasury Green Paper entitled Strengthening the Incentive to Save: a Consultation on Pension Tax Relief. This consultation runs until the end of September and asks a series of questions about whether the current system of pension tax relief is working.

While the chancellor’s Budget speech referred to one particular reform, the document itself is much more open. It sets out eight questions about the effectiveness of the current tax relief regime and provides a set of four principles against which any reforms should be judged. Rather ironically, given the changes already announced for April 2016, one of them is “simplicity and transparency”.

The chancellor suggested in his speech that any reform would only be about the tax treatment of new pension savings, rather than for existing pensions. I suspect that this was a political call, designed to avoid the inevitable headlines (which happened anyway) about the threat to take away ‘middle class’ tax breaks. But if reform was only about new pensions then it would be decades before we would start to see any real impact.

The far worse change is the tapering of the annual allowance

One reform under consideration is a switch to Isa-style tax treatment. This would mean that pension contributions would be made out of post-tax income, but pensions would be tax-free. The problem is that the public are expected to believe politicians when they say: “We’re taking away your tax relief, but don’t worry because we won’t be taxing your pension in some decades’ time”.

This sounds like a tough sell. But the bigger question is why anyone would bother to tie his money up in a pension product without upfront tax relief when he can put his money into an Isa with the same tax treatment and instant access?

A clue came when the chancellor hinted that there could be a government ‘top-up’ to pension accounts as part of any reform. Such a top-up could be used very creatively to give the biggest rewards for saving to those who most need encouragement to save for a pension – low to middle earners and young people. It would also be a relatively simple approach compared with current systems of pension tax relief.

But the problem is that we have over 10 million people who are not saving enough for their retirement. Changes to tax relief for new savers, however welcome, will do nothing to tackle this fundamental and urgent problem.

What is really needed is a once-and-for-all overhaul of the whole pensions system, including those who are already saving. The huge sums currently spent on tax relief could be much better spent on a simpler system, such as a flat rate of relief for all. For example, a 33 per cent rate of relief could be presented as a £1 government contribution for each £2 you put in to a pension.

With a sensible and fair rate of relief, and a sensible annual allowance, it would be possible to get rid of the complexity of lifetime allowances (and tapered annual allowances) altogether. There would be something in this proposal for everyone.

We must not let our gloom over the shocking short-term changes to pensions close our eyes to the window for reform which has just been opened, however narrowly. Over the next few months I hope we will see a growing consensus for carefully considered, proper reform of pensions tax relief so that we can genuinely tackle the crisis of under-saving in this country.

Steve Webb was minister of state for pensions between 2010 and 2015

Key points

The reduction of the lifetime allowance to £1m will simply make matters over the lifetime allowance worse.

Real damage could come if top and middle managers decide to do minimal pension saving.

What is really needed is a once-and-for-all overhaul of the whole pensions system.