The origins of the current system for the taxation of pension schemes tell us, inter alia, that –
- A common tax regime for approved/registered pension schemes took over 50 years to achieve
- Tax-free lump sums on retirement came about more through accident than design.
Lessons to be learned from the history of pension tax reliefs are –
- Uniformity of tax treatment for different types of pensions, which took so long to achieve and has now been in place for several decades, should not, without good reason, be disturbed
- Despite it now being an embedded part of the pensions landscape, an informed debate on the utility of the tax-free lump sum on retirement is long over due.
Previous research on the current pension tax relief system contains some common conclusions, including -
- The current UK pensions tax relief system is not properly understood nor is it incentivising pension saving (especially amongst lower and middle income earners)
- The ‘single rate’ and ‘matching’ ideas are considered attractive in terms of having the potential to address this, with a single rate of pensions tax relief expressed as a matching contribution also being very easy to communicate
- Arguably, saving for retirement is different from other forms of saving (something that is not always recognised with other, more radical models for reform, especially where they include provision for early access to savings).
Therefore, if it is accepted that the key reason for a review of the pension tax relief system is to decrease the number of older people who rely on means-tested benefits, a single rate of relief, set above the level of the basic rate of income tax, could encourage lower and middle income earners to save more. The outcome would be an increase in people able to retire with dignity and a reduction of the burden that would otherwise fall on the shoulders of future tax payers.
Such a change, when expressed as a matching contribution, also has the benefit of being easy to understand and represents a more evolutionary reform to the current pension tax relief system relative to more revolutionary suggestions that do not appear to be as well aligned to the above objective.
One factor that we do not consider to be relevant to the review of pension tax reliefs is current economic circumstances. This assumes that the objective of reform is a robust and sustainable system which incentivises the right people and helps protects future generations of workers from increased taxes.
In other words, reform must be based on sound, lasting principles and not be motivated simply by the prospect of a short-term increase in public revenue.
Based on the above, our principal recommendations are that –
- the current pension tax relief system should be replaced by a matching system (set at a minimum level of a £1 government match for every £2 saved but with consideration given to a more generous match, at least at the point of establishment of the new system); and
- tax-free lump sums should be capped for the future.
We believe that –
- these represent the right changes for the right reasons;
- properly implemented they could also result in a reduction to the cost of pension tax reliefs; and
- they build on and are consistent with the role of government which is to provide individuals with a foundation (the State pension), nudge them in the right direction (auto-enrolment); and incentivise them to make adequate provision for their later life (tax reliefs).
Nevertheless, if it transpires that these reforms are not achieving the objective of adequate retirement incomes for the vast majority of low to middle income earners then the re-introduction of some form of compulsion for saving in respect of later life may be the only way forward to avoid pensioner poverty, higher taxes or both.
Read the full report.