One joy of UK Parliamentary democracy is watching the annual budget with its howling Government MPs, roaring Opposition MPs and ritual interventions of the Deputy Speaker to allow the Chancellor to finish off his speech.
On 8 July the Government doubled down on budgets for the year. In between making the Secretary of State for Work and Pensions happy with a living wage announcement and mocking Boris Johnson's opposition to Heathrow's expansion, the Chancellor put forward a consultation that could lead to some radical change to pensions taxation in the future.
Much of the "bread and butter" proposals for pensions were unsurprising and had been flagged by the Government previously:
- The annual allowance (the amount a person can save with tax privileges towards their retirement in any given year) will be tapered for high earners.
- Anyone with total earnings (including their pension savings in that period) of £150,000 or more will have the standard £40,000 allowance tapered away. There will be a £1 reduction in the allowance for every £2 over £150,000 they earn or pay into their pension. The taper is capped at an income of £210,000 combined earnings and pensions saving with a fixed annual allowance of £10,000.
- The taper will not apply to a person who has earnings of £110,000 or less, even if they are paying more than £40,000 into their pension (though. of course, that is the annual allowance!).
- However, a high earner trying to dodge this taper by entering a salary sacrifice arrangement to increase pension contributions whilst reducing their earnings below £110,000 will trigger anti-avoidance powers.
- Administratively all pension input periods have closed with effect from 8 July 2015, and the Government will be putting in place transitional reliefs.
- The Government's plans to implement its 'sell your annuity' framework will go ahead but in 2017 rather than 2016.
- The Government will tax inherited pension benefits after a member's death on or after their 75th birthday at the recipient's marginal income tax rate rather than the current punitive rate.
- The lifetime allowance (the amount a person can save with tax relief for their retirement across their lifetime) will reduce to £1,000,000. This will add yet another layer of transitional protections to cover anyone prudent enough to have already saved more than this amount.
In the "lesser" of the two consultations, the Government confirmed that it will consult on the use of unfunded EFRBS for tax avoidance, with an aim to removing this tax planning choice.
The real "sting in the tail" is the second consultation. The Treasury has already started consulting on whether it should reform the current system of pensions tax relief.
The main difference between the tax treatment of ISAs and pensions is when you pay tax. For ISAs taxed income goes in, tax-free income comes out. For pensions tax-relieved contributions go in, taxed income (subject to the option to take a 25% tax-free lump sum) comes out. In both cases investment returns are not taxed.
One of the options the Government is considering is to tax ISAs and Pensions as income in, untaxed income out products. This seems to be based on some comments from the Pensions Minister before she was appointed, and a paper from the Centre for Policy Studies (CPS) proposing a "workplace ISA" style saving product. The CPS paper suggested that this could replace existing occupational pensions savings. It also dangled up to £10 billion of front-loaded taxes in front of the Treasury.
The Treasury's consultation is considering this and any other options put forward by the industry to address the most obvious problems with the current system. For example, pensions tax relief is weighted heavily towards high earners whilst tax relief on contributions is also "invisible" and takes a lot of explaining.
The Treasury stresses in its consultation that the current system may well be the best structure to get people to save, although it acknowledges this might not necessarily be the case. We agree that this is an area to explore. There is little point in maintaining the status quo if it does not meet the objective of producing decent retirement incomes for people.
The current system has advantages. For example, the "front loading" of tax relief on pension contributions means more money is available to generate investment returns, a key factor in good retirement outcomes. Current pensions legislation is also very good at forcing people to keep their savings in place till retirement which is otherwise an enormous temptation during difficult times. This is something that ISAs as a short to mid-term investment product are expressly designed not to do (and arguably what makes them popular to younger savers).
Also, that £10 billion of extra income to put towards the budget will be matched, and potentially exceeded, by tax income foregone on pensions income in retirement.
Of course, there are improvements to be made. Often these are "political" questions on where the Government should focus its incentives to save for retirement, but there is one legal area where it could do some good.
If the Government decides to keep the existing system, then it should leave it alone for a while. The continual paring away at the annual and lifetime allowances and tax relief tapers is turning the "simple" A-day system into a nightmare of transitional protections, tax traps and unintended consequences. Long-term saving needs settled rules, and tinkering around the edges merely complicates matters. The Government should either make the big changes to introduce "fairer" pension savings, or leave the existing system alone so that people understand what they can put into their pension from one year to the next.