The phasing out of the additional personal allowance was decried as a ‘granny tax’ but that move did not go far enough. A new CentreForum report looks at two unjustified and deeply regressive age-related tax breaks: the tax-free lump sum and the exemption from National Insurance.
There are many lonely, vulnerable and poor pensioners who need support. But it’s insulting to suggest that everyone over 60 or 65 can be lumped into the category of frail granny (to say nothing of grandpas!). There is a huge range of incomes amongst pensioners. At the very top, the average annual pension of a FTSE100 director is £240,191 and will benefit from regressive tax breaks at every stage.
Note also that pensioners and non-pensioners are ultimately the same people: the question is when is the best time of life to receive tax breaks. It is surely less useful in later life when people are far less likely to have mortgages to pay, child care costs or student debt. We all know how economically and socially important it is to invest in children’s education and living standards, and it is difficult to see how tilting the balance in favour of pensioners achieves this same long-term social value.
Even if you think a tax break is most useful later in life, it’s currently the richest pensioners who benefit most, as the graph below shows.
Encouraging pension saving is important but taking a tax-free lump sum means a lower annual pension, contrary to this idea. We propose phasing out the tax-free lump sum (not affecting current pensioners) and applying National Insurance to the incomes of affluent pensioners. Together these would raise a whopping £9.2bn per year.
With all parties committed to closing the deficit, we must ask whether these tax breaks are a good ‘use’ of money. Are they better than investment in infrastructure, child care, or averting the £10bn of extra welfare cuts that could be made? Are they the best way to target spending or tax breaks at the lowest paid, including poor pensioners? We show, for example, that using the money to increase the personal allowance by another £1,700 would be much more progressive – both for all households and for pensioners. Only a third of future pensioner households – the richest third – would be worse off.
We must also consider the Dilnot cap on social care costs, a welcome move but one that benefits rich pensioners most. This same group should fund it through measures like these. Other options include ending higher rate tax relief and means-testing age-related benefits, but right now it seems more likely that the money will – for political ease – instead come from young people and general welfare cuts.
Inevitably, if the Coalition proposed ending these tax breaks it would be denounced by some as ‘an attack on the poorest and most vulnerable in society’ but this graph and report should make clear how untrue that is. Click here to read the full report.
* Adam Corlett is an economic analyst and Lib Dem member
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20 Comments
A lot of sensible proposals here. I have never understood the justice in pensioners paying signifantly less tax than employees because of National Insurance exemption. Having said that, extending N.I. contributions to pensions would be hugely unpopular amongst this demographic.
Excellent work.
If only those of working age voted at the same rate as the retired (or the soon-to-be).
Absolutely, but look how the debate on such things was shut down following the last budget with simplistic slogans like “granny tax”, “charity tax” and “pasty tax”.
The enemy here is Labour. We can’t expect anything better from the Tories, but Labour at least ought to see that joining in with right-wing attacks on taxation is painting themselves into a corner. Sure “nah nah nah nah nah, rotten Liberal Democrats sold their principles for jobs with the Tories” works better immediately than a serious debate on reform of taxation with the aim of closing up the growing gap between rich and poor. However, even if by destroying us electorally they do gain a majority rather than turn most of the seats we have won back into the Tory seats they used to be, what happens then? Having joined the Tory press in making it politically impossible to talk about these things they are stuck – what will they do, borrow more and whistle on the hope something turns up?
@Matthew – yes.
Lots of good work coming from Centre Forum – impressed.
@Duncan – If only those of working age had the same amount of free time and disposable income!
There has been a lot of work addressing pensioner poverty in the last few years – and Steve Webb’s changes to include a triple-lock guarantee means pensioner income will continue to rise appropriately.
Research on the Minimum Income Standard @JRF.org.uk shows that welfare support for pensioner’s income is now above the MIS, meaning that all now have enough to meet normal living costs 🙂 – whereas for working age people, it meets less than half of normal living costs, resulting in serious hardship such as “heat or eat” scenarios.
So it is fair for wealthy pensioners to pay fair levels of tax. Recent changes labelled as the “granny tax” actually just mean they will pay the same income tax as everyone else. It is fair that those with the highest incomes also pay the same national insurance as the rest of us!
“The original intent that National Insurance provided insurance against unemployment, sickness and old age is now a fiction.” p45 Tax Justice, CentreForum.
That statement is almost true and is becoming more so.
You could have saved yourselves a degree of work by simply calling for the end of National Insurance and its incorporation into the income tax system.
I am with Guy on this one “You could have saved yourselves a degree of work by simply calling for the end of National Insurance and its incorporation into the income tax system.”
In fact combing income tax and NI into a single tax that applies to all forms on income (earned and unearned) may be the only politically feasible way of doing this.
@Guy and Joe: As you may have seen in my other LDV posts, I agree about merging NI and income tax. But given that we propose an extra pensioner NI allowance in this paper, and don’t propose levelling employer NICs on pensions in any way, this might be more politically feasible than a full merger right now.
Thanks for all the other supportive comments (so far)!
I am currently looking at annuities as I reach retirement age this year. Taking a cash lump sum is a no brain option as, even at current interest rates, putting it in savings bonds will be a better option than the 20 years it will take before the difference between maximum pension or reduced pension balances out, I don’t expect to live that long given my health. If the cash free option didn’t exist I’d be much more inclined to pay no more into my pension than my employer would match via the loophole of salary sacrifice and put the rest into ISAs. In case there is any doubt i was a 40% tax payer when employed and will only just be a tax payer, thanks to the LibDem increase in the tax bands and rubbish annuity rates.
Wow, the choice of a cash lump sum or annuity (where your income is still high enough to pay tax) is a much nicer decision than “heat or eat”.
Or if you’re unlucky and paying over half of your income in rent, you might have to Not-heat and eat less too.
You might still be paying the 9% university “tax” as well!
Agree with Peter’s point about the tax-free lump sum. If it weren’t there, I’d be tempted to put less in my pension and more in savings accounts just in case I need the money when retiring (e.g. to pay off the last bit of a mortgage). As I am less good at working out where to invest things than a professional and might be tempted to spend it early, this would probably be bad for me overall, but I’m sure a lot of people would do it – which would counteract all the work being done to encourage private sector workers to save for retirement.
Might it not make more sense to put a lower cap on the amount of lump sum that can be taken out, rather than abolishing the possibility altogether?
Peter’s point is also a good one – if, as now, annuity rates are terrible, it may make sense for pensioners to get some income from an annuity and some from other sources (e.g. bonds). This flexibility seems like a good thing that should be preserved – so if abolishing the tax-free lump sum, would it be possible to preserve it by saying that a maximum of 25% could be invested in an income-bearing account? I know very little about the range of products on offer, so this may be infeasible…
As for higher rate tax relief, I used to be all for getting rid of it, but wouldn’t this create a two-tier system between those with salary sacrifice schemes (who wouldn’t be affected as the amount comes out of their pre-tax pay) and those without (who would be able to claim less tax back so would be net worse off), which seems a bit unfair.
But yes, agree with the general thrust of the article. It annoys me when people with more money than me pay less tax, ESPECIALLY when they then also get lots of perks like the free bus pass and winter fuel allowances, and ESPECIALLY when so many of them pay so much less in housing costs due to either owning their homes outright or being in social housing.
The tax free lump sum is one of the main reasons for saving towards a private pension. It should be limited (as it is now) – perhaps the limit lowered – but it should NOT be phased out. It would be a huge breach of trust against those choosing to save for a pension – something government should be encouraging. Phasing the lump sum out would affect millions of ordinary people who are young now and taking the risk of locking away their savings today in order to help them in retirement – it will reduce the incentive for saving but most importantly would take away something that people had genuinely saved for.
I agree with the broad thrust of the article that those who earn more should pay more and should not be exempted on the basis of being “grannies”. But completely disagree about taking away the tax free lump sum.
The tax free lump sum is popular but as the graph shows, it is very, very regressive. Even limiting it to £40k will still give more to people who are affluent than to people who are not. That is why we favour phasing it out in the long run. (The phasing out is not a reneging, however, since all we propose is to end “future accrual”, that is, future pension savings won’t lead to a bigger lump sum).
“we propose an extra pensioner NI allowance in this paper, and don’t propose levelling employer NICs on pensions in any way, this might be more politically feasible than a full merger right now”
Adam, how is asking pensioners and future pensioners to continue to pay a tax which they thought they would finish paying when they retire ‘politically feasible’?
@Guy: No, I don’t imagine levelling NICs on even just richer pensioners would be a popular move. I said it would be *more* feasible than charging them NICs without the extra allowance we propose – which is what I thought you and Joe were suggesting.
@Laura: I believe you’re right about that problem with scrapping higher rate tax relief. I think it is possible to account for but it’s administratively complicated. The IFS often complain about the idea, and think levelling NICs and reducing the tax-free lump sum are better options.
@Adam. Really? Your proposal is to charge retired people an extra 12% tax in return for nothing (that will be headline grabbing granny tax figure). Although link is strained, National Insurance contributions do still have an impact on entitlement to benefits (Maternity Allowance, for example, and, at the moment, State Pension) and the public (and HMRC) still believe that to be the case. The politics around asking people to pay a tax which they believe gives them entitlements to benefits they will never want is even worse than Thatcher’s Poll Tax. (The fact that the revenue from National Insurance is placed into the general revenue pot is irrelevant to the politics of your proposal.)
Although the tax-free lump sum is regressive, might it not also have benefits in encouraging people to save for retirement? If it were abolished entirely I would be very concerned that people would put less in their pensions, instead putting it in lower-rate accounts and being tempted to get it out early and thus ending up with less money come retirement. This would have a disproportionate impact* on those with smaller pension pots, so I’d be concerned that although the headline impact might be progressive, there could be unintended consequences that disproportionately affect poorer people. Private sector workers already have terrible pension provision, so I’d be concerned about anything that might make it worse.
*by which I mean that although they might lose less in absolute terms the difference in resultant pension would make a relatively big difference to their standard of living.
@Laura, yes the TFLS is meant to encourage pension saving. But (the majority of) pension contributions are exempt from employee and employer NICs at the contribution stage, as well as when taken as pension income. So even if we had a limited employee NICs equivalent for pensioners, there’d be a large incentive to put money into a pension.
If you think more incentive is justified and needed, it could surely be done in a more progressive manner, and one that doesn’t make people take their money out immediately and risk a lower income for the rest of their retirement!
@Guy, There aren’t many ways of closing the deficit that are politically popular, as we’ve discovered. We shouldn’t simply aim to avoid offending those who shout the loudest.
@Adam – the problem is that your paper is all about making the tax (sic) system fairer. It is not fair to use a tax (sic) which those paying it and those who used to pay it believe is designed to provide entitlement to specific benefits. By all means challenge that assumption – in which case abolish National Insurance. A simpler and more integrated tax system without national insurance would be easier to make fairer as fewer of the special tax breaks so beloved of Gordon Brown would be necessary to correct anomalies.
Bear in mind that only pensioners who are currently working are exempt from National Insurance (not as your paper implies all pensioners) – so it’s misleading to call all pensioners’ non-liability a tax break.