Please can we stop raising tax out of people’s pensions?

Reading my Spring Conference papers, I saw with interest the motion F7 “Making Tax Fairer”. Would we be doing something to simplify Britain’s massively over-complicated tax system, I thought? Might we be proposing something really radical like linking the personal allowance to the minimum wage or something to address the way people earning much less than the 50% top rate of £150,000 can pay much higher effective rates of tax, more than 50% – sometimes more than 60% – because of withdrawal of tax credits and then Labour’s inequitable withdrawal of the personal allowance?

No, I’m afraid we’re not doing any of those things..

This motion is not about tax fairness – it’s about raising more tax. And in particular, hitting people’s pensions to do it. A financial transactions tax – a so-called “Robin Hood Tax” – sounds like such a good way to raise money, doesn’t it? Let’s tax all those nasty bankers’ actions in the city. And it’s only a tiny little amount of each transaction but it raises so much money… Right?


Firstly, it’s not taxing “the bankers” – it’s taxing the money that they are investing, and mostly that means the funds of pension plans, insurance companies, savings schemes. It means millions of ordinary people’s money. That’s why there’s so much of it.

Secondly, if it raises a lot of money then it’s not a “tiny little amount”. Look at the total you plan to take out of the City – that’s got to come from somewhere and where it’s going to come from is the growth of pension and insurance funds. That means worse pensions and higher insurance premiums, not just for “the bankers” but for everyone.

We’ve seen this happen before.

In 1999, Labour Chancellor Gordon Brown abolished a thing called Advance Corporation Tax. This was a deal where companies would pay an amount of tax on account whenever they paid dividends. The logic being if they could afford to pay their shareholders, they could afford to pay HM Treasury a bit too. People receiving the dividends could then treat them as “tax paid”. The wheeze was that pension funds, which didn’t have to pay tax, could then claim back an extra 25% on all dividends.

That meant that a chunk of corporation tax was going straight into the pension funds and it made pensions a really good investment that grew ahead of the market. It made sure that the pension funds would be big enough, when the time came, to pay for people to get a good pension. From Gordon’s point of view, though, that money belonged to the Treasury, so he put a stop to it.

That took a huge bite out of the pension funds’ incomes, and Gordon Brown’s raid on A.C.T. is one of the main reasons that almost all private final salary schemes have been ended, and why Danny Alexander is having such a tough time with the unions over public sector pensions. So rule one: before you decide to take a huge bite out of pension funds, remember what the consequences will be.

Well, what about the other tax-raising method: “limiting the relief for payments into pension funds, which” – allegedly – “currently offers the greatest benefit to higher rate tax payers”. I can see how this looks like easy money, the same as the Robin Hood tax.

At the moment, if Ms Basic, a 20% taxpayer, pays £80 into her pension the government matches that with £20, so she gets £100 in the pot, as it were. But if Dr Higher, a 40% taxpayer, pays £80 into her pension the government not only makes that up to £100, but also gives Dr Higher £20 back. That does look like free cash for the 40% taxpayer, doesn’t it.

But you’re not seeing the whole picture. That £20 is not a gift from a generous government. It’s your own money being given back to you. As in “we believe people know how to spend their own money better than governments do”. The simple principle is: you don’t pay tax on the money you put into your pension.

Ms Basic earns £100 and gets £20 taken away in tax. Her pension contributions cost £80 and the government gives her her £20 tax back. Dr Higher earns £100 and gets £40 taken away in tax. Her pension contributions also cost £80 and the government gives her £20 tax back into her pension, leaving her £20 worse off. Which is why she gets the £20 pension credit.

Pensions are not like putting money into a savings account. For starters you can’t get it back until you retire and even then there are strict conditions about what you have to do with the money. But if you put £100 into a savings account you would not expect the government to tax you on taking it out again. Well, you do get taxed on your pension income – and that’s because you didn’t get taxed when you put it in. We used to have a principle of not taxing people twice on the same income. “Limiting” the higher rate pension credit would break this principle.

Suppose you did a deal with your employer that you would get £100 less each month, but get £1200 at Christmas. You wouldn’t expect to pay tax on the £100 that you’re not getting, would you? Well, that’s how pensions are supposed to work – you agree not to take a chunk of your income now in return for getting it “at Christmas” or rather after you retire.

Let’s say Mr Company, another 40% taxpayer, agrees with his employer that he will surrender £100 of salary a month which they will pay into the company pension scheme. Because he’d have paid 40% tax on that, this only reduces Mr Company’s take home pay by £60.

So if you abolish the pension credit, you end up with a situation where there are two people getting the same income and pension but one of them, Dr Higher, pays £80 for her pension and the other, Mr Company, only pays £60. You’ve taken away her tax refund, but he doesn’t need a pension credit to refund his tax because he never paid the tax in the first place.

How is this making tax fairer? Do we want people to make provision for their retirement? Should we encourage people who pay into pension plans or penalise them? Do we want pensioners to be independent or forced to rely on the generosity of future governments?

The ideas behind this motion are very well-intentioned: the desire to redistribute income to the lower-paid by raising the taxes paid by the better-off. And I fully support the other ideas in the motion – the mansion tax and the general ant-avoidance rule. But if we want tax to be simpler and more transparent we need to be honest about redistribution and put the 40% rate up to 41%. (Or if we’re being really honest and including National Insurance, the 42% rate up to 43%.)

Don’t do it by making pensions so poor an investment that people just don’t bother with provision for their old age at all.

* Richard Flowers has been a Party member for 20 years. He’s campaigned in many an election, stood as a local councillor, and Parliamentary candidate, was Chair of Tower Hamlets Liberal Democrats, and in 2020 was Liberal Democrat candidate for the Greater London Assembly constituency of City and East. He is currently English Party Treasurer. Thanks to Liberal Democrats in government, he is married to his husband Alex Wilcock. He also helps Millennium Elephant to write his Very Fluffy Diary.

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  • The point you make about double taxation is a red herring. Virtually no-one who gets 40% tax relief ends up paying higher rate on their pension income, because very very few people have a pension income upwards of £35k. Most higher rate or additional rate taxpayers will get relief at 40 or 50% (those on around £110k can actually get 60% relief) but taxed on the eventual income at 20% or less. So the double taxation point is essentially irrelevant – this is about incentivising savings through the tax system.

    We need to stop seeing pension tax relief as, well, tax relief. It is public subsidy of private saving designed to encourage saving in a particular form. It costs the Exchequer 2.2% of GDP – no other area of public spending that expensive gets by with such little attention. To put that into context, that’s more than the combined budgets of the DfT, MoJ, DECC, DEFRA, and DCMS. It is staggeringly ineffective – just read some of the research by (among others) the Turner Commission to see that hardly anyone *understands* tax relief, let alone see it as an incentive to save.

    If we genuinely care about pension provision for the many not the few, then taking some of the tax relief currently going to the very highest earners and give it to the very lowest (in the form of stepped matched contributions – paying directly into a pension fund to match what a person pays themselves, to make it more explicit what is happening) shouldn’t be controversial. Less than 4 in 10 adults are accruing a non-state pension. and most of those are on low-incomes. It is absolutely right that we provide them with more explicit, more generous incentives to start saving than continuing to subsidise the very highest earners.

    I’m a self-identifying economic liberal, but I’m not a libertarian. The state is there to do a bit more than just give tax back to people.

  • This article seems a bit confused to me… if your boss agrees to not give you £100 (on which you might have paid £20 tax) and then gives you £1200 at the end of the year you’d still expect to pay the same tax (£240 overall). Just because you defer income doesn’t mean you should get to avoid the tax.

    In addition to this, you’re saying we should “encourage” people to move back to private pensions but really you’re saying we should have additional rules to “incentivise” people. Personally, I’d rather we taxed all income fairly regardless of whether you claim it now or in 30 years. Doing this would allow less taxation overall and therefore people will be in a position to contribute more to their pensions overall.

  • @Tommy
    “Just because you defer income doesn’t mean you should get to avoid the tax.”
    If I read the article correctly then this isn’t what is actually being said. What’s being said (I think) is that you wouldn’t expect to pay tax on the 100 pound every month and then also pay tax on the 1200 when you get it at the end of the year (i.e. getting taxed twice on the same money).

    This leads to pensions, if you’re not getting the money now because you’re putting it aside for retirement, should you be taxed on the money you put into the pension pot as well as getting taxed on it when you take it out during retirement?

  • Chris Nicholson 6th Mar '12 - 10:37am

    Ben is right that the double taxation argument is a red herring. See P20-21 of Dick Newby’s CentreForum paper . Given current annuity rates even if you have the maximum pension pot (£1.5M from April 2012) it is now just about impossible to pay tax at 40% on your income from a tax advantaged defined contribution pension scheme. There is no justification for higher rate tax relief on pension contributions

  • I was on Jobseekers Allowance for a short while last year, now they tell me that is taxable… bonkers or what!

  • Malcolm Todd 6th Mar '12 - 11:26am

    Why is it bonkers, Peter? It’s income. Most income is taxable. The fact that it comes from the government is neither here nor there — lots of income does. But if you earn, say, £18,000 for nine months’ work then get JSA for three months (making a total income of nearly £19,000), don’t you think it’s right that you should pay more tax overall than someone in a less well-paid job who earns £18,000 for the year and doesn’t get any JSA?

  • Malcolm Todd 6th Mar '12 - 11:31am

    Sorry, that was a bit off-topic. On the main point of the article, I’ve always been in favour of doing away with higher-rate reliefs, but on the specific issue of pension contributions it’s hard to maintain the line. Richard’s right — this is a different sort of saving, precisely because you pay tax on the pension when it comes. (And also because you can’t just spend the money you’ve saved up — you have to take it, or at least the bulk of it, as income, which means some of us will never get back what we paid.)
    On the other hand … we don’t generally allow people to average their income over years in order to reduce tax liabilities. If I earn £50,000 this year (ha! ha!) and only £20,000 next year, I won’t be able to claim back the 40% tax I paid on this year’s earning on the grounds that on average my income is below the 40% threshold. Isn’t that exactly what higher-rate pension tax relief does?

  • JustAnotherVoter 6th Mar '12 - 12:56pm

    That CentreForum paper is making a really bad argument. When interest rates “normalise” annuity rates should rise and the pension pot size required to pay HRT will be much lower (£840K at 5% gets you £42K/year).

    But I cannot believe the wider point is missed. The UK economy is crying out for more investment. Capital investment is what creates new technology, improves productivity, improves our long-term standard of living.

    The very last thing the government should do is take £5bn/year of saving out of the economy, and spend it on, what… consumption? The idea that this appeals sickens me, it is the absolute reverse of good policy. We need more saving, less consumption; our future prosperity depends on it.

  • I support the conference motion for more pragmatic reasons. Rational and persuavive arguments, on the grounds of fairness, can be made for either restricting relief for pension deductions to the rate most likely to recovered on the future pension income or allowing relief against the marginal rate of tax on the income from which contributions are made.

    There is however the pressing issue of how to fund the bringing forward of an increase in the personal allowance to £10,000 . Restricting relief on pensions contributions to the 20% basic rate would furnish the funds to intoduce the £10k allowance in the coming budget..

    Contrary to some of the arguments above, I believe that we do need an economic stimulus to demand as a means of boostng confidence in the economy that ultimately underpins business investment. A demand stimulus is best achieved at this time by a focus on enhancing the purchasing power of low and middle-income earners.

    The argument highlights the distorting effects of different rates of income tax at higher income levels and on different sources of income. Combining income tax and national insurance into a flat rate of 32% to be applied to all sources of income including pensions and replacing higher rate tax on income with wealth taxes such as the Mansion tax could remove these anomalies. The higher combined rate of tax on pensions would fund the payment of a more progressive increased flat rate state pension or citizens income as a supplement to the basic pension. . There is a more detailed discussion at Tax and Benefit Reform

  • Good article Richard, I suspect that many of the people who have commented so far don’t make any voluntary contributions into their pensions and hence just don’t comprehend what you are saying.

    I think many people have become infected with Gordon Brown’s viewpoint and fallen into making the erroneous assumption that “the money “belongs” to the Treasury rather than the people who earned it in the first place.” even when the Treasury has incorrectly charged the taxpayer and so has to make a refund. This is the only rational explanation I can come up with for all those statements along the lines of:
    “We need to stop seeing pension tax relief as, well, tax relief.”
    “It costs the Exchequer 2.2% of GDP”

    Yes I agree this motion is yet another attempt to pile yet more taxes on to our pensions, which are already being taxed multiple times:

    Firstly, we are taxed on our initial contributions; fortunately the government currently wishes to encourage Pension savings, and have decided that this saving should be taxed like Capital Gains namely when it is drawn down and so refunds the Income Tax paid, but not the NI you pay on your contributions from your gross taxable pay.

    Secondly, investment growth generated through income is, thanks to Gordon Brown, now subject to taxation. (Aside: ISA investments are also subject to this taxation)

    Thirdly, the pension pot itself is subject to tax if its annual growth exceeds HMRC defined limits.

    Fourthly, the entire pension pot (consist of original contributions, capital and income growth if any) is subject to the normal rates of income tax applicable when it is finally drawn down.

    So we can see that some constituents of the pension pot are taxed at least twice.
    Because Pensions are a lifetime investment, the only fair way to change pension rules is to have them apply only to new starters, namely to baby’s born after a specific date (yes baby’s because even children can have their own pension plans).

    I hope that all those who are arguing for increasing the tax take are also lobbying their MP’s to reject the proposed changes to CFC taxation that HMRC forecast will reduce tax revenues by £1bn per annum by 2015 (see

  • Excellent post. Good to see I’m not the only one dismayed by motion F7.

    A financial transactions tax (particularly when called a “Robin Hood” tax) sounds like it must be a good thing but people aren’t really looking at who will be hurt most!

    @Matthew Green, that sounds like a pretty succinct summary of why company pension schemes are dying but I’d also throw in the changes in accountancy standards that made these liabilities more visible (IAS19 if I remember rightly).

  • The Gordon Brown “tax raid” was accompanied by a cut in corporation tax of 2p, IIRC. This doesn’t seem to ever get mentioned. It was a simplification exercise.

    Higher-rate pension tax relief (actually comes to 50p with a salary sacrifice) is really a way of spreading out your income over a lifetime and paying a lower average rate. It’s fair enough, as long as people don’t then insist that HRT are paying much higher average rates and that those are unfair too.

    One thing I think people aren’t aware of is the restricting HRT relief on pensions won’t just apply to employee contributions but employer contributions, so many people will see their take home pay drop quite a bit.

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