Advisers have called on the government to be attentive when considering any changes to pension tax relief after provider Hargreaves Lansdown suggested it should be abolished in favour of government top ups.
Several advisers warned if the government were to make any changes to the way pension tax relief works, the plans would need to be well thought out, avoid unnecessary complications and the process would take time.
This comes after Hargreaves Lansdown published a paper in which it urged the government to announce in the upcoming March budget a review of the UK’s pension tax rules.
Under current rules tax relief is paid on savers' pension contributions at the highest rate of income tax they pay.
But Hargreaves Lansdown has suggested this method should be scrapped and replaced by a pension top up system, either through the government or the employer.
Under the provider’s proposals all employee contributions would be doubled irrespective of their tax bracket. Hargreaves proposed three tiers of contributions.
For example, under tier one tax relief would be abolished on employee contributions but the employer’s minimum contribution would be raised from 3 per cent to 5 per cent.
This means every £1 paid into a pension by an employee will be at least doubled, with a salary cap on auto-enrolment contributions of £100,000.
Under tier two, employers would have the option to offer employees the right to pay up to an additional 5 per cent of pay into their workplace pension. Every additional £1 would then be matched by the employer.
This would give a maximum total pension contribution of 20 per cent of pay, again with a salary cap of £100,000.
The last tier, for those ineligible to save in a workplace pension or those wanting to top up their savings, is a £10,000 individual savings allowance, which would be matched by the government.
Nathan Long, senior analyst at Hargreaves Lansdown, said the government must reform the tax relief system now before it gets worse in the future and becomes even more complicated.
Currently the tapered annual allowance, and the net pay pension administration system are the biggest issues when it comes to tax relief.
The taper is hitting higher earning public sector workers with punitive tax bills, whilst the net pay system means some employees earning below the income tax threshold get no tax relief on their pension contributions.
Mr Long said: “Both the tapered annual allowance and net pay anomaly are horrible issues and to solve them in isolation will have knock on consequences. They both heap a lot of complexity into the system and our view is that we need a simple solution and we can do this now and change the system to remove complications.
“One of the things we are getting more agitated by is that tax relief is supposed to be used as an incentive for people to save but what has happened is that it has become a subsidy for people to save.
“It is time to re-examine this system and ask whether this is the best way to incentivise people to save more.
“In the budget we want to see a consultation that tackles these issues and to not just have a sticking plaster over the two headline issues at the moment.”
But advisers have warned that any radical reform will take time and could add further unexpected complications to the system.
Alan Chan, chartered financial planner and director at IFS Wealth & Pensions, said while Hargreaves Lansdown’s suggestion could work, it was too radical to be introduced in a short timescale.
Mr Chan said: “While some suggestions are good, taken together they appear to be very radical changes that will completely transform the pensions landscape – something that cannot be done overnight and needs to be carefully weighed up.
“I just fear that pensions may be made even more complicated by this.”
Mike Lacey, partner at financial adviser firm Bowman Pension Consulting, said: “Any call to review the current pensions regime is of course welcome but I do feel the government needs more than five weeks to give proper consideration to the matters raised by Hargreaves Lansdown.”
He added that Hargreaves Lansdown's suggestions for reform would put more onus on employers and could remove the need for a workplace pension.
Mr Lacey said: “Looking at the suggestions for the auto enrolment space; an increase in employer contributions would be seen as a tax on employers.
“Removing tax relief on employee contributions would lead to the savvy employee asking employers to contribute to their own individual pension, which would be an administrative nightmare to monitor. The employee contribution would be seen effectively to reduce, which could present communication issues for employers.
“I welcome the call for reform, but there should be a decent consultation period with input invited from a wide variety of contributors.”
amy.austin@ft.com
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