Cutting tax relief on pension contributions for higher earners, we are told, would fit with the new Tory mantra of “levelling up” the country. Not so. Reducing the size of the average pension pot and making more people reliant on the state in retirement is levelling down. It’s not aspirational, it undermines personal responsibility, and I don’t believe any Conservative chancellor, no matter how big his party’s majority, would ever do it. The system is too embedded, the political fallout would be toxic and the practical cost for businesses (not just for savers) is too great.
Even George Osborne — who as chancellor so loved to chip away at the pensions system — wasn’t brave enough to tackle this troublesome issue.
That said, I suspect other bits of the pension system may well be up for grabs. Some argue that the current system of reliefs is unfair, in that a £1 contribution costs a basic-rate taxpayer 80p but costs a higher-rate taxpayer only 60p. About 60% of reliefs are handed to higher-rate payers.
The flip side of this is that, put another way, pension relief is deferred tax: you might not pay it on the way in but you do on the way out. So scrapping this principle will in effect mean that anyone on the higher rate will pay tax twice. It will cost them 44p to save, even if you include the tax-free lump sum.
There have been those pushing for a flat-rate system — so that we all get, say, 30p for every £1 contributed. But anyone who thinks a chancellor will reform tax relief and simply redistribute the reliefs available in the current system is living in la-la land. As I wrote here a few weeks ago, every chancellor in the past 25 years has looked at the £50bn in reliefs handed out on pensions every year and thought: “I’ll have a bit of that, thank you.”
With almost 10 million more people now in a workplace pension thanks to auto-enrolment, the tax relief bill — even at the basic rate — is growing massively.
All this isn’t to say that pensions tax relief acts as an incentive to save. Most people don’t even know it exists.
I suspect the chancellor will back away from higher-rate relief reform when he realises the full ramifications.
Besides, if the argument is about fairness, there are more practical and effective ways to make money from pensions. He could cap the 25% tax-free lump sum — an enormously generous giveaway. However, limiting it to, say, £100,000 would hurt only the very wealthiest pensioners, given that the average pension size is less than £200,000. It would also incentivise people to turn their pensions into an income in some way.
Also up for grabs are national insurance reliefs on pension contributions made by businesses — that’s £11.2bn. Finally, and only whisper it, you could make workers over the state pension age pay national insurance contributions.
Over the past 20 years, the number of over-65s in work has risen from 455,000 to 1.31 million. With an increased burden on social care and the state pension, allowing this group to avoid paying national insurance on their earned income is anomalous.
I would be shocked if the chancellor scrapped higher-rate tax relief in the budget, but I would not be surprised if we got a major consultation on our rickety pension system.
Watchdog barks but seldom bites
I know newspapers get accused of scaremongering, but you should read last week’s Sector Views report by the Financial Conduct Authority. Investment mis-selling, final salary pension transfers, high-risk mortgage lending, the dangers of big data and open banking, high investment costs, bank fraud . . . basically everything a Money reader knows about already.
It is encouraging that the regulator can see the threats to consumers. The challenge it always struggles to rise to is acting on them — and quickly.
Source: The Sunday Times February 23 2020