‘Pension tax system illogical’: Researcher

‘Pension tax system illogical’: Researcher

The current “illogical” system of pension tax relief should be scrapped and replaced by a range of Isa products, according to Michael Johnson.

The research fellow at the Centre for Policy Studies said the current tax system is incompatible with the abolition of the annuitisation requirement announced in the 2014 Budget and risked failing an entire generation.

He said this was because increasing numbers of people will not be taking their savings as income, shattering the link made by Lord Turner’s Pension Commission in 2005.

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Mr Johnson said it would be cheaper to move to a taxed exempt exempt system (TEE) than spending £52bn – more than the annual defence budget – on pension tax relief.

He said: “This is at odds with how those in Generation Y, in particular, are living their lives.

“Many eschew pension saving, thereby missing out on tax relief, but engagement with Isas is high.

“Ready access and flexibility is valued above tax relief: EET is patently failing the next generation.”

In his summer Budget, chancellor George Osborne announced a consultation into the taxation of pension savings.

In his speech to the House of Commons at the time, Mr Osborne said he was open to “further radical change” in pensions, adding they “could be taxed like Isas”. This has led to speculation that pension Isas are in the pipeline for the next Budget.

Mr Johnson proposed the creation of a workplace Isa for the auto-enrolment sector which would prevent withdrawals before the age of 60 and trap the incentive, along with income and net capital gains.

Meanwhile a Lifetime Isa should be introduced, he said, which would be eligible for an upfront incentive paid irrespective of tax-paying status, up to a modest annual allowance.

Withdrawals before the age of 60 would require repayment of the incentive and savings made after 50 must remain in situ for ten years.

Gillian Guy, chief executive of Citizens Advice, which provides the government’s Pension Wise, agreed tax relief does not incentivise saving.

She said: “Tax relief alone will not encourage enough people to save adequately for their retirement.

“People need to understand how much they should save now to have the income they need for the future, and government needs to look at how they can help people achieve this.”

Not everyone agreed with the premise. Malcolm McLean, senior consultant at Barnett Waddingham, said: “It could have a devastating effect on contribution levels through auto-enrolment, and run the risk of a future government reneging on the promise to pay the pension tax-free.”

The total amount of money subscribed to adult Isas in 2014/15 was £79bn in 13m accounts.

Total membership of occupational pension schemes with two or more members was 30.4m in 2014.

Adviser view

Independent retirement adviser Alan Higham said: “Tax is a disincentive to save for retirement, and that’s the last thing we should be doing at the moment, but I fear the writing is on the wall. Pensions is the perfect area for a stealth tax, as chancellors of all colours have found.