The Finance Act 1921 introduced the concept of tax relief for pension schemes that satisfy certain criteria. Almost 100 years later this tried-and-tested system may well be turned on its head...

Consultation

The level of tax relief available has been fiddled with countless times over the decades, but the approach to the actual application of tax relief under pension schemes has always been the same – tax relief is given on the contributions being paid into the scheme; investments grow in a (largely) tax-free environment; and income tax is due on the benefits when they come into payment (the "exempt, exempt, taxed" approach).  That has been a constant.  However, the Government is considering yet another major shake-up to the world of pensions and HM Treasury issued a consultation paper in July suggesting a major change to this simple system.

Motivation

The Government asserts that the motivation behind the proposed change is the recognition that pension saving has shifted from final salary arrangements to money purchase arrangements, the fact that people are living longer, and the Government's long-term goal of getting people to take responsibility for their pension saving.

Of course a key issue for the Government is the growing cost of pensions tax relief.  It claims that certain measures have been necessary to ensure that

  • public finances are kept sound; and
  • pensions tax relief is targeted at pension savers who need it most. 

Such past measures, including the introduction (and subsequent reduction) of the annual allowance and the lifetime allowance, increasing the state pension age and encouraging workplace saving via auto-enrolment appear to have been insufficient from the Government's perspective.  The concern is that many people are simply not saving enough to provide them with the funds that they will require during their retirement.

Illustration

The graphs published in the consultation paper suggest that the annual amount of pension tax relief provided by the Government each year is nearing £50billion.  Of course the Government does receive tax revenue from pensions in payment, which should be offset against the tax relief figure to establish the actual cost to them.  However, the cost to the Government of providing pensions tax relief is undeniably material.

The proposal involves bringing the taxation of pensions forward instead of deferring it until retirement.  Under such an approach pension contributions (employee and employer alike) would be taxed; the Government would top up the contributions; and benefits would be paid tax-free.  There is no detail regarding the potential top-up – could this be a flat rate?  We doubt it will be a matching contribution, else where would the benefit for the Government be?

The key principles which the consultation paper identifies are:

  • transparency;
  • personal responsibility;
  • building on the success of auto-enrolment; and
  • sustainability.

Differentiation

Leaving aside financial implications for the Treasury, what we must ask ourselves is whether a shift in the approach to taxation would really make much of a difference to people's attitudes towards pension saving.  I am of the view that such a change is only likely to reduce individuals' interest in using pension arrangements as the headlines are likely to suggest that the Government is making this change for its own gain – to reduce the financial burden of giving pension tax relief.  And even if the popular press overlook this most obvious of headlines, what incentive is there to save into a pension if there is no "free money" at the point of doing so...?

The proposal is incredibly vague and the consultation says in several places that the conclusion may well be that the existing system is the most appropriate option.  If this change is to take place it will be interesting to see how the Government proposes to deal with the logistical issues such as how tax on employer contributions will be collected and how existing schemes would be kept separate from savings made into schemes after the change were made, so that members do not suffer double-taxation.

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