Former pensions minister Baroness Ros Altmann has called on the government to reform the current tax relief system suggesting that a new approach could raise revenue and improve pension outcomes for low earners.
In its manifesto, the Conservative government promised that within 30 days of being elected it would address the problems caused by the taper but Baroness Altmann suggested that radical reforms to the pensions tax relief system may be better suited to fix this issue as it could also save money.
She said reforming the system, which costs the government £50bn each year, could also help to solve the NHS pensions crisis where complex tax rules have forced senior clinicians to pull out of the pension scheme and cut down their work hours.
In her latest policy paper Baroness Altmann said: “By signalling the damaging effect of attempts to clamp down on pension tax relief for higher earners under the current system, the government may decide that pension incentives and tax rules need a broader review.
“Rather than trying to reform the tapered annual allowance and lifetime allowance just for medical staff, ministers may be tempted to revive reforms of pension incentives considered in 2015/16.”
Back in 2015/16 the government looked at three options for reforming the system: leave it as is, change it to an Isa-style pension system where contributions are taxed but withdrawals are tax free, or move to a flat-rate of tax relief.
However, any attempts at reform were dropped in the run up to the Brexit referendum.
One option floated by Baroness Altmann was to make the legal minimum auto-enrolment contributions compulsory and remove tax relief from this amount.
Currently, the minimum contribution rate is 8 per cent, made up of 3 per cent from the employer, 4 per cent from the employee and 1 per cent from tax relief.
She said: “The extra money put into workers’ pensions from the 3 per cent employer contribution is much more than the 1 per cent from tax relief.
“As the ‘free money’ added by employers dwarfs the impact of tax relief, the billions of pounds spent on auto-enrolment by taxpayers seems poorly targeted.
“Compulsory employer and employee contributions would eliminate the need for taxpayer incentives and could be a timely revenue-raising reform.
"Government incentives would then only be added to contributions beyond the minimum, and could be more generous for average earners than the current system, in order to encourage more people to build above the minimum and drive better overall retirement provision.”
Another option would be to limit the tax free lump sum available at retirement.
Currently, individuals are able to take 25 per cent of their pension fund tax free but Baroness Altmann has suggested by limiting this to a cash amount, say £100,000 per person, it could help save the Treasury money.
Baroness Altmann also backed the idea of introducing a more transparent system and move to a flat rate of tax relief.
She said: “Moving to a more transparent system with a uniform amount that the government adds to each person’s pension contributions – maybe 30p added for every £1 contribution – would be more generous than basic rate tax relief, less than higher rate relief and much easier to understand.