Experts warn against major pension tax changes

Experts warn against major pension tax changes

Any major attempts at altering pensions taxation are unlikely to be successful, as the existing system is the one that "causes the least harm", experts have warned.

Speaking at the Pensions and Lifetime Savings Association’s annual conference this week, Laura Myers, PLSA board member and head of defined contribution at LCP, said none of the most commonly cited options for pensions tax relief reform has so far met the five criteria set out by the industry body.

Any reform should promote adequacy, encourage the right behaviours, be fair, be simple to adopt and administer, and be enduring and sustainable, according to the PLSA. 

The current system meets three of the five criteria, but none of the possible alternatives meets more than two, she noted. 

Moving to a flat rate of 25 or 30 per cent, for example, would promote adequacy and encourage the right behaviours, but would not be simple to adopt and administer.

Reducing the lifetime allowance and the annual allowance would be simple to adopt and administer and would be enduring and sustainable, but meets no other criteria. The same is true for removing national insurance relief on employer contributions.

The rest of the options, such as splitting the defined benefit and DC regimes, a single rate of 20 per cent, or capping the tax-free lump sum at £75,000, either only meet one of the objectives or — in the case of a taxed-exempt-exempt treatment — meet none.

“It’s hard because, quite frankly, you wouldn’t start from here. You end up looking at the least worst situation on radical reform,” Myers said. 

“And then, when you delve into the actual numbers on potential benefits for some groups, the amount that the government could generate, those figures are really uninspiring.”

In the case of a flat 25 per cent rate, for example, the government would only generate £0.6bn of the £5bn it would be looking to raise, and that is before tax relief is decoupled from income tax, she explained.

“So on balance, it’s the existing system that we support that matches our criteria the most closely. We know that’s not perfect, but really it does cause the least harm,” she said.

Overly generous taxation

Carl Emmerson, deputy director of the Institute for Fiscal Studies, argued there were areas in which the existing pensions taxation regime was too generous, and from which the government might look to source more money.

He pointed to three areas in particular where changes might be made.

The 25 per cent tax-free lump sum, for example, is not “that well targeted”, and placing a cap on it would make more sense than capping the amount that can be saved tax free annually or in total, he said. 

Making employer contributions exempt from National Insurance is likewise “extremely generous” and is benefiting from unintended subsidies from the raising of NI rates and the cutting of income tax, he said.