The government must stop tinkering with tax relief and take a more long-term approach to pensions policy or savers will be deterred, writes Samuel Dale
Pensions tax relief is in the political spotlight again as the parties propose a dizzying array of changes ahead of the general election.
Since 2010, the lifetime allowance for tax-free pension pots has nearly halved from £1.8m to £1m, while the annual allowance on contributions has fallen from £255,000 to £40,000.
The changes have come through a series of small measures in successive Budgets and Autumn Statements, but the industry is calling for a long-term plan to create stability.
Many argue that the constant tinkering is deterring people from saving and creating new layers of complexity.
The most recent changes were in the Budget in March, when Chancellor George Osborne cut the lifetime allowance from £1.25m to £1m.
The government rejected Labour calls to cut the annual allowance further from £40,000 a year to £30,000.
Osborne said that 96% of pension savers would be unaffected and it would rise in line with inflation from April 2018. “The government say only 4% of people will be affected, but our suspicion is that it will be more,” says Hugh Nolan, chief actuary at JLT Employee Benefits.
“It is a punitive tax for those who have saved well and done well on investments. People who have, say, £700,000 are now worried that, having scrimped and saved, they could pay a lot of tax if their investments do well.
“It seems backwards to take away from those who have planned over 20 or 30 years. It is fundamentally unfair to entice people into saving money and then tax them heavily on it afterwards. The moving goalposts are worrying.”
Nolan says the move won’t just affect millionaires, but those on modest retirement incomes, too. He points out that a £1m pot would only buy an index-linked, joint annuity of around £30,000 a year.
And there is no end in sight for the tinkering. The party manifestos were published in April with a plethora of new ideas to take away tax relief from wealthier pension savers.
Labour reiterated a long-standing commitment to cut tax relief for those earning more than £150,000 a year from 45p to 20p to fund cuts to student tuition fees and a jobs scheme for young workers.
More surprisingly, the Conservatives would launch another raid on tax-free annual allowance. From April 2017, the party would introduce a tapering system.
Those earning more than £150,000 would be able to put £40,000 a year into their pension pot tax free but it would fall to just £10,000 a year for salaries of £210,000 and above.
Some have compared it to Labour plans before the 2010 election to introduce a new charge on those receiving higher rate pensions tax relief.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “It is complicated, and that is the worry. Labour tied themselves in knots in 2008-09 with its higher-earner excess relief charges. I worry that if the Tories go down this route with the annual allowance, then it will get complicated with salary sacrifice.
“For example, if you have someone earning £190,000 a year they could simply tell their employer to pay them £150,000 and put £40,000 into their pension pot.
“The Tories could look at taxing employer contributions, but then it is complex. Or savers might not realise the annual allowance has been reduced and unexpectedly pay tax.”
The policy is designed to raise £1bn in revenue in order to fund an inheritance tax cut allowing a £1m family home to be passed on tax free.
“This has nothing to do with creating a better UK savings policy, but simply to find money to pay for inheritance tax cuts,” says McPhail. “That might be a good policy, but it should be separate from pensions and savings.”
Meanwhile, the Liberal Democrats, whose MP Steve Webb has held the position of pensions minister for the past five years, called for a review of tax relief in their manifesto.
It states: “[We will] establish a review to consider the case for, and practical implications of, introducing a single rate of tax relief for pensions, which would be designed to be simpler and fairer and which would be set more generously than the current 20% basic rate relief.”
Webb has long supported a flat rate of relief and has previously floated 33% as his preferred level.
Workplace Pensions Live will be the first major gathering of the pensions industry, following the general election. To find out the implications for tax relief, book your place here.
The dangers of tinkering
Many in the industry worry about the long-term damage to savings policy of the constant tinkering and changes on tax relief by the politicians.
Bhargaw Buddhdev, a partner at Barnett Waddingham, says: “Senior people can afford to pay for financial advice to deal with any changes but as the tax relief limits go down then it will start to have an impact on more people who won’t be able to afford advice.
“In addition, altering things is making it more and more complicated, and it means senior people that will lose interest. If they lose interest then they will lose interest in pensions for their staff, too.”
Jamie Jenkins, head of pensions strategy at Standard Life, says there needs to be a long-term strategy. “There are a lot of examples of tactical tinkering,” he says. “The focus on cutting tax relief has been on how the money is used elsewhere, rather than pension saving. If we’re going to restructure tax relief then stop messing about with it and let’s do it properly.
“We need to work through tax relief and come to a long-term stable solution rather than making changes every year that is just creating complexities in the market.
“Anything that creates another level of pension saving, such as cuts to the lifetime allowance or salaries above £150,000 is complicated. How, for example, will defined benefit schemes be affected?”
With the next government still facing a £90bn budget deficit and £1.5trn debt, the pensions industry accepts that more cuts are coming.
“Labour, Tories and the Lib Dems are all calling for tax relief reforms so it is inevitable there will be change,” says McPhail. “It is up to the industry to make a credible case for a measured approach.”
The Centre for Policy Studies (CPS) calculates pension tax relief cost £52bn in 2013-/14. It is broken down as £27bn coming from upfront tax relief on employee contributions; £14bn from National Insurance contributions on employer contributions and salary sacrifice; £4bn from the 25% tax-free lump sum; and £7.3bn of investment income flowing tax assuming the basic rate of tax.
“The juiciest and lowest-hanging fruit in Westminster is pensions tax relief, which is also enormous,” says Michael Johnson, research fellow at the CPS.
“The three main parties have ruled out cuts to VAT and increases in income tax so they are left with no choice but to chip away at £101bn worth of tax reliefs on offer, with pensions being the largest.
He adds: “All parties know that any tax relief changes they make will have more losers than winners so they tinker. The way they minimise the political damage is to focus on a narrow band of people each time. It is clear tinkering.”
Johnson favours the merging of Isas and pensions tax wrappers, with clear and generous tax relief for savings. He says: “None of the parties are thinking about a big plan to boost saving in Britain. No one has asked how effective tax reliefs are and they do not know.”