The Government has been consulting on changing the current pensions tax relief regime to cut the amount it ‘gives away’ each year. HM Treasury published its consultation paper entitled Strengthening the incentive to save: a consultation on pensions tax relief on the same day as last summer’s Budget.
If you read between the lines of the 23-page document there is no doubt that the Treasury is worried about the rising cost of its annual pensions tax relief giveaway that is increasing exponentially with auto-enrolment bringing so many more employees into pensions savings. Since 2009/10 the Government has seen a jump in the tax relief it has paid out from about £30bn to nearer £35bn last year. However, if you include relief on both Income Tax and National Insurance Contributions (NICs), the Government relinquished nearly £50bn in the 2013/14 tax year.
You could also argue that the current pensions tax regime is inequitable as higher rate taxpayers get much more benefit from tax exemptions than lower income basic rate taxpayers as contributions go into their pensions. And yet, when they come to withdraw these savings, they are generally taxed at the basic rate of 20 per cent once their incomes have fallen steeply in retirement.
This inequity, as detailed in The Institute of Fiscal Studies’ (IFS) savings tax reform study, and also reinforced by thinking from the Centre of Policy Studies (CPS), is clear. To fix this, Michael Johnson at the CPS has long-campaigned for the pension tax regime to be switched from the current exempt-exempt-taxed system (or EET) to the taxed-exempt-exempt (TEE) system of tax payment mirroring the system used for ISAs.
But after a great deal of deliberation, the IFS concluded that the current EET system should be retained but that this should be accompanied by “the removal of the excessively generous and distorting treatment of employer contributions (that is, allowance of NIC relief in addition to income tax relief on pensions contributions). The IFS report added: “The tax-free lump sum is an odd method of providing an additional incentive for saving in a pension.” The IFS favours replacing the tax-free cash (TFC) with a reduction in tax rate paid on pension withdrawals. The ABI favours moving to a simpler but perhaps less generous flat tax relief regime or ‘saver’s bonus’ based on 25 to 33 per cent of contributions. Tisa has even gone as far as to cost a saver’s bonus at 33 per cent and has found it to be eminently affordable.
So now that all the options are on the table, what will the Chancellor decide to do? We all expected an announcement from him on this in his Autumn Statement last month, but it did not come. Still, there is no doubt George Osborne has been looking at pensions tax relief changes over the next month as he will need to determine how much new money is likely to be coming into the Treasury before he finalises his spending plans in time for the spring Budget on 16 March.