Michael Johnson is a research fellow at the Centre for Policy Studies.
Traditionally, pensions and politics have rarely mixed, primarily because policy initiatives imply change, and in the pensions arena that usually means more losers than winners. So, if you are a politician, the general rule has been to avoid the theme. But the recent Budget demonstrated that boldness in respect of pensions policy can be a source of significant political capital, as evidenced by the post-Budget polls. There are further opportunities to harvest the pensions theme, notably concerning retirement saving incentives, which cost over £54 billion last year. If the objective is to catalyse the broad-based retirement savings culture that Britain needs, today’s framework has flagrantly failed. Why?
The underlying cause is that today’s framework faces a fundamental dilemma. Income tax is progressive……so tax relief is inevitably regressive. Consequently, the net effect is, for many wealth people, to nullify what is intended to be a progressive tax system. In reality, tax relief is first and foremost a core component of personal tax planning (i.e. minimising the amount of income tax paid), rather than a saving incentive.
My new paper for the Centre for Policy Studies, Retirement saving incentives; the end of tax relief, and a new beginning, attempts to address this issue, by proposing the scrapping all tax relief on pension contributions and replacing it with 50p from the Treasury per £1 saved, on up to the first £8,000 of annual savings.
This is akin to a 33.3 per cent flat rate of tax relief but, to be clear, it would not be a tax relief as currently understood, because it would be paid irrespective of the saver’s taxpaying status. This structure would focus all of the Treasury’s incentive on the first £8,000 of an individual’s contributions, where it is most needed, and would double the rate of incentive that basic rate taxpayers (some 85 per cent of the workforce) could receive today.
An incentivised savings capacity of £12,000 per year (including the Treasury’s 50p) needs to be seen in the context of current savings habits. In the last reported year, 5.4 million individuals made pension contributions (personal and occupational) averaging £1,630 (and that includes basic rate tax relief), with another £1,670 from employers: £3,300 in total, a figure that is seriously distorted by the relatively few very large contributions from high earners. Clearly, £12,000 per year is more than enough for perhaps 95 per cent of the population (and the proposals include the ability to roll up perhaps ten years’ of unutilised capacity).
Last week, Steve Webb, the Liberal Democrat Pensions Minister, voiced his support for a 30 per cent flat rate of tax relief, with the caveat that “clearly ,that is not government policy, it is not even LibDem policy yet, but I’m working on that.” Webb knows he has to be careful, because tax relief is not part of his brief: it is Treasury business. So, why say anything? It could be that Webb has seized an opportunity to differentiate the LibDems from their coalition partners but, equally likely, his intervention represents a “land grab” of what is now blindingly obvious territory for Labour. It is indeed extraordinary that the top one per cent of earners, in least need of financial incentives to save, receive 30 per cent of all tax relief, more than double the total paid to half of the working population.
The Conservatives may ignore this inequitably distribution at their peril, not least because it partly explains our lack of a broad-based retirement savings culture. In addition, pensions tax relief could become part of the glue that binds a Labour-LibDem pre-election coalition agreement, and itould have widespread appeal. The Conservatives need to head off that risk. The Autumn Statement would be a good time to do it.
The eight specific proposals in Retirement saving incentives; the end of tax relief, and a new beginning are:
- Pension contributions from employers should be treated as part of employees’ gross income, and taxed as such.
- Tax relief on pension contributions should be replaced by a Treasury contribution of 50p per £1 saved, up to an annual allowance, paid irrespective of the saver’s taxpaying status.
- ISA and pension products should share an annual combined contribution limit of £30,000, available for saving within ISA or pension products (or any combination thereof). This would replace the current ISA and pensions tax-advantaged allowances.
- The 25 per cent tax-free lump sum should be scrapped, with accrued rights to it protected.
- The Lifetime Allowance should be scrapped. It adds considerably complexity to the pensions landscape, and with a £30,000 combined contributions limit for pensions and ISAs, it would become less relevant over time.
- The 10p tax rebate on pension assets’ dividend income should be reinstated.
- People should be able to bequeath unused pension pot assets to third parties free of Inheritance Tax (perhaps limited to £100,000), provided that the assets remained within a pensions framework.
- The annual allowance should be set at £8,000, with prior years’ unutilised allowances being permitted to be rolled up, perhaps over as much as ten years, all subject to modelling confirmation.