'We must not forget pension tax change prompts behavioural response'

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'We must not forget pension tax change prompts behavioural response'
(FT Money)

Most people would agree that pensions are good for you.

And in an era where we are living longer, their importance as a means of funding our later years is growing.

The state simply can’t afford to provide everyone with a comfortable retirement, so it’s important individuals, along with their employers’ support, save for themselves. This is why the government introduced auto-enrolment, to get millions more saving into workplace pensions.

But for most people, minimum AE contributions won’t provide the income they’ll aspire to, so incentives to top these up voluntarily, or even not to opt out, remain hugely important. 

For many decades, pension contributions have attracted tax relief on the way in, funds grow free of tax and after a tax-free portion, proceeds are taxed as income when taken. There are also special tax treatments of death benefits that were changed more recently when pension freedoms were widened. 

However beneficial private pension savings are to individuals, and also to the state, the tax incentives to encourage those savings come at a cost to the exchequer – for 2020-21 this was £48.2bn.

There are also questions around the fairness of how tax reliefs are spread, with 52 per cent going to higher rate taxpayers and 6 per cent to those paying additional rate. 

People who have been ‘doing the right thing’ shouldn’t suddenly find the rules have changed before they benefit from the proceeds.

Lifetime and annual allowances were introduced to avoid any individual receiving ‘too much’ tax relief, but they create their own challenges, including discouraging higher paid individuals over the age of 55 from remaining in the workforce.

The money purchase annual allowance, limiting contributions to £4,000 once a defined contribution pension has been accessed flexibly, is even less defensible. 

The chancellor recently set out his four E’s of economic growth. Within this, under employment, it’s been reported that he may be considering relaxing at least some of these ‘allowances’ as part of his drive to get early retirees over 55 ‘off the golf course’ and back into work.

Fingers crossed the March 15 Budget will announce an end to the current freezes and hopefully some step increases.

It would mean collecting a little less in income tax by granting a little more pensions tax relief, and less collected in tax penalties for those who breach the limits. But the upside in terms of keeping people economically active for longer could far outweigh this.

More fundamental reforms, whether to save the chancellor money or to spread reliefs more fairly, are often centred around moving away from offering tax relief at the individual’s highest marginal income tax rate and instead offering a flat rate of tax relief for all, irrespective of earnings.