In a report published today, the Pensions & Lifetime Savings Association sets out the principles on which any reform of pension taxation should be based and assesses the impact of a set of major reform options on savings, savers, and schemes.
Pension tax relief exists to help people save larger amounts towards their retirement and encourage them to voluntarily contribute more. Essentially it rewards people for locking away a portion of their income until they are at least 55. It is generally accepted that most people are not saving enough for retirement. According to a PLSA report in 2016, only about half of working people are likely to achieve the target replacement rates identified by the 2006 Pensions Commission and only 3% of those who have only defined contribution provision.
Over the last year, there has been regular speculation that the Government plans to reduce the level of fiscal support for pension saving with touted changes ranging from removing higher rate income tax relief, reducing the annual or lifetime allowance, introducing a flat rate of tax relief for all savers of 25% or 30%, or overhauling the system so that all pension contributions are taxed at a person’s full marginal income tax rate upfront (known as TEE).
As the Chancellor prepares to deliver the Budget on 3 March, the PLSA has identified five principles on which pension taxation should be based and has considered whether the range of reforms most frequently discussed satisfy them.
Five Principles for Pension Taxation
- Promotes adequacy: provides financial support and incentivises saving for retirement.
- Encourages the right behaviours: helps savers make the right decisions about retirement saving
- Fair: helps everyone – the employed, the self-employed, and non-workers - save for retirement
- Simple to adopt and administer: avoids unreasonable transition and on-going costs for employers and schemes
- Enduring & sustainable: designed to avoid repeated change and so builds confidence in long-term saving.
Tested against these principles, none of the main options for reform or the current system of pension taxation achieve all the principles.
TEE – whereby pension contributions are taxed at a person’s marginal rate of income tax but investment returns and pension income are exempt – is particularly harmful as it would result in lower pension saving for all income groups, result in less money for the Exchequer in the future as society ages, and remove the incentive for people to lock away their money until later life. This approach was considered by HM Treasury five years ago and rejected.
Removal of higher rate tax relief might save the Exchequer between £8bn and £10bn per year but it would not improve pension adequacy for people who pay the basic rate of income tax as it would involve no change for them. However, we estimate that three to four million higher rate taxpayers (those earning £50,000 or more) would have to pay £2,000 or more in tax per year.
A move to a single rate would have very substantial implications for the administration of occupational pensions resulting in much higher costs for employers and schemes, likely in total to amount to millions of pounds. A reform of this magnitude would take at least two or three years to implement. Some experts believe it would result in the end of defined benefit provision in the private sector.
The PLSA’s Five Principles for Pension Taxation report includes PLSA analysis of Pensions Policy Institute modelling to illustrate the impact of different reform options on a range of individuals with different earning and tax profiles and who are members of different types of pension scheme. While some of the reforms can result in higher private pension income for some groups of savers, even under the most generous scenario, one where Government would adopt a single rate and give a 30% rate of relief, the biggest improvement any saver in a defined contribution pension scheme would see to their income replacement rate in retirement is only 1 to 2%. This suggests that even major reforms might make relatively little difference to retirement income.
Nigel Peaple, Director of Policy and Advocacy, PLSA said: “More, not less, pension saving is needed so that everyone will have an adequate income in retirement.
“We recognise that the UK is facing a very severe economic and fiscal environment as a result of the pandemic; but any potential reforms should be fully thought-through and assessed. The Five Principles for Pension Taxation can help Government make the right decisions.
“Our assessment suggests that no single reform or the current system is perfect. Most reform options leave many people with lower pension savings and create very substantial cost and complexity for employers and occupational pension schemes.
“Introducing major change to the system of fiscal support for pensions risks undermining hard-won confidence in pensions. This, in turn, could undermine the gains made in recent years, particularly through the advent of automatic enrolment and improvements in governance.”
NOTES FOR EDITORS
The current tax treatment for pensions in the UK is described as EET: exempt on contributions, exempt on investment returns and taxed when taken at retirement – apart from 25% which is tax free. Restrictions are placed on the amount of pension tax relief an individual can receive, in particular through the Annual Allowance and the Lifetime Allowance. These rules apply across both defined benefit and defined contribution pensions.
Click the link to read the full Five Principles for Pension Taxation report.
Mark Smith, Senior PR Manager
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Steven Kennedy, PR Manager
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