Not content with the most radical reforms to private pensions in a generation, Steve Webb is proposing a flat rate of 30% of tax relief on pension contributions. Currently savers enjoy tax relief at the marginal rate of income tax they pay, so higher rate tax payers get the lion’s share, and standard rate tax payers have less incentive to save for a pension.
Steve told the Daily Mail
I’d like to see the benefits of pensions tax relief spread much more evenly.
Most people get 20 per cent relief, some people get it at 40 per cent. But the people who get it at 40 per cent get shed loads. If you gave everybody 30 per cent then that spreads it much more evenly. Clearly that is not government policy, it is not even Lib Dem policy yet – but I’m working on that.
I’m not convinced that the pension reforms have all been Liberal Democrat policy so far. Steve seems determined to get three times as much done as the party would have thought possible.
There is a simple and compelling logic to the current system: that when you save for a pension you are shifting income into the future, and so you pay income tax on it in the future instead of the present.
However if the point of this tax relief is to encourage pension saving for the avoidance of hardship in old age, then it makes sense to boost the incentive for people at greater risk of hardship – i.e. those on lower incomes. For higher rate tax payers, paying into a pension can become attractive purely for tax efficiency, which suggests their incentive is too great.
* Joe Otten was the candidate for Sheffield Heeley in June 2017 and Doncaster North in December 2019 and is a councillor in Sheffield.
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28 Comments
It makes most sense, to me, to offer 20% tax relief only.
After all, people rarely pay 40% tax on their pensions, because very few pensions are that high.
Higher rate relief will be gone in two or three years, at most. It would also be worth capping the amount on which tax relief is given at a far smaller amount, albeit that everybody should be entitled to make contributions as they wish.
It is sufficient for the growth in the fund itself to be exempt.
Steve makes the opposite argument – that cutting tax relief for top rate taxpayers makes the lifetime cap unnecessary.
I think this is a good idea but it doesn’t address the anomoly that if the employer makes a pension contribution he avoids paying NI, as does the employee, but if the employee makes the contribution both have to pay NI.
I don’t know if 30% is the best figure, but after recent changes to personal pensions, this seems like a good way to prevent a high earner from getting high tax relief on pension contributions shortly before retirement and then cashing in shortly after on a lower marginal rate.
I don’t agree. We should keep marginal tax relief – why pay into a pension to get 30% relief and then pay 40% on the way out? It’s just complicating the system further. I mean, why get 30% anyway, if you only pay 20% tax? It’s just a random figure, not even linked to NI. Regards.
@Graham Evans – The issue isn’t so much the anomaly of employee contributions, but that HMRC, discourage employers/employees switching to “non-contributory” arrangements.
Given how expensive it is to employ people, I find it a little surprising that employers are still offering schemes that require an employee contribution. The only rationale I can come up with is that they are too busy saving tax to actually save tax! Back in the 80’s my colleagues noted that companies were obsessed with saving income tax whereas with a slightly different focus they could available themselves of a substantial NI contribution saving, with no real difference to the take home salary and benefits package of their employees.
Obviously, things are currently slightly different with AVC’s.
In order not to fall foul of one of my pet hates – leaving out inconvenient information – I should also mention the 25% tax free lump sum benefit that people get from pensions. However, if higher rate tax relief is cut then it does question whether pensions will be worthwhile for higher rate taxpayers, who generally aren’t rich.
I am in favour of a proper discussion on pensions, but please let’s have a grown up debate, something Steve Webb has failed to do in the past when he has resorted to smearing the pensions industry with “full frontal assaults”, misleading arguments and highly exaggerated figures. Proof of which I can provide on request.
Whilst Steve Webb (deliberately?) overlooks the simple fact that the low pay receive disproportionally more from the state than the higher paid, I think the real thing he omits to say is that in the future for the state pension to be affordable, it will have to be significantly lower than it is today and hence we need to find ways of encouraging people, particularly the lower paid to save more towards their pension. The idea of once again taking away from those who by definition contribute more to the state than they already get in return just smacks of envy.
I suspect that one of the consequences of Steve’s scheme would be to increase the amount of unfunded pension tax relief being given out by HMRC. At present all pension tax relief is based on tax actually paid (or due to be paid); Steve’s proposal removes this linkage and hence could result in the government having to find funds from other taxation.
A scary thought has just occurred – the Pensions Minister either doesn’t actually know or want us to know, just how much pension tax relief HMRC are giving out! Instead the linked Mail article has to rely on a guestimate from the Pensions Policy Institute.
Steve Webb is to be congratulated for starting the discussion and acknowledging that it is not Lib Dem policy. There are always going to be different views so let’s have the debate and see where the facts lead us. Don’t blame him for thinking it in the first place.
There are other reasons why it might be justifiable to cut higher rate tax relief, so I don’t want to criticise the idea too much, it is just hard to have a discussion on pensions that is both easy to follow and representative of the truth. Even previous attempts at pensions simplification under New Labour were dubbed “pensions complication”, because of tricky issues such as old scheme rights.
Thanks Fiona, I agree.
Someone earning £100000 PA gets 10 times as much tax payer subsidy for his/her pension than someone earning £20000. This cannot be right, especially in a time of austerity. I favour limiting tax relief to the basic rate with a cap limited to the basic rate band, ie £6000 per year.
The savings could be used to fix many other problems, eg implement the Dilnot cap at £35000, not £70000
Andrew, your claim of 10 times as much taxpayer subsidy is not accurate because pensions are partly tax deferral. One of the reasons why the “Lamborghini” policy was brought forward is because of this tax they pay on exit. You don’t receive the income twice, so you arguably shouldn’t pay the tax twice. Again, it gets more complicated than yet, but that is broadly why we have the relief.
Our policy at the last election was to remove higher rate relief and I still agree with that. It makes no sense for the state to subsidise the pension pots of the top 15% of earners at twice the rate it subsidises others.
Seems to be heading towards Ukip ideas which were condemed
To reply to Eddies point
Pensioner and working tax liability is not the same. Pensions are normally substantially lower per annum than earned income, typically 50% or lower. Hence a pensioner is unlikely to be liable for higher rate tax unless his/her income was very high c >£80K. In addition all pensioners will get the state pension + additional benefits like free TV licence, bus pass, winter fuel allowance etc. Note I do not favour means testing these as means testing is expensive and bureaucratic.
Would this mean giving tax relief to people saving for a pension who don’t currently pay tax? Although that might sound outlandish ti does make sense if you have an untaxed income (e.g. a student grant or support from someone you are caring for) and are also working part time. At present saving for a pension under these conditions can mean moving income from a present where it is not taxed to a future when it is taxed, so by Andrew Ducker’s argument it seems that some relief is called for.
Andrew, thanks for your reply. At the moment only a small percent are paying higher rate tax in retirement, but after drawdown liberalisation many more will be paying higher rate tax on the way out. My guiding principle here is to prevent double taxation, which not only makes me feel warm inside, but also saves from some unpleasant headlines :).
I’m not ruling out the idea, I just like to tread carefully (most of the time).
Steve Webb is thinking along the right lines in proposing a flat rate of 30% tax relief on pensions. However, as Eddie Sammon notes in his comment – pension relief is a tax deferral not a permanent tax saving – you pay tax on the income you have saved when you draw your pension.
The solution I would favour is the combing of the 20% basic rate of income tax and the 12% ‘earnings tax’ into a single flat rate of 32% that would apply to all sources of personal income for both relief/deferral purposes and as income was taxed. Higher rate income taxes could also be replaced with a Land Value Tax.
A flatter tax regime of this sort would alleviate anomalies such as higher rate pension relief and provide for a simpler and more progressive tax system.
Simon, I believe non-taxpayers can already get tax relief on pension contributions up to a limit of £3600 a year after relief. Aimed at non-earning spouses for example.
@Simon Beard & Joe Otten
Yes that was my belief concerning the original Stakeholder (personal) Pension – which was capped at £3600 net contributions per annum. But a quick look at the pensions site, it looks as if the new Stakeholder (employee) pension has different rules.
As far as I know the £3,600 rule is still in effect. I’ve checked HMRC, but I’ve made a mistake in the past by assuming their website is up to date. For free impartial financial information I would go to the government’s Money Advice Service: http://www.moneyadviseservice.org.uk. Alternatively, you can find a financial adviser here: http://www.findanadviser.org.
Just to point out that it is not £3,600 NET, it is £3,600 GROSS. In other words, £2,880 NET. It’s available for everyone, including children.
There is a big question behind this debate; what is welfare for? Should it be contribution related ie individuals get back something proportional to what they put in or should it be a form of communal insurance for those who hit hard times (eg illness, loss of job). Whilst the former is popular amongst politicians and others, I strongly favour the latter. I think tax should be seen like house fire insurance, everyone pays in but only a few benefit in the end. The former model is very expensive because it needs to pay a wide range of recipients and is no longer affordable in my opinion.
Hence subsidies to those who are not really in n eed, eg higher rate tax reliefs, childcare and housing benefit to those in low paid jobs should all be questioned.
Andrew, I argue that tax deferral is not a handout, rather an intrinsic part of the pensions system. However I do think the 25% tax free lump sum should be looked at.
I agree with you entirely that the state is not there to provide for those not in need, I want big action on this too.
Even the 25% tax free lump sum is arguably an intrinsic part of the pensions system, I don’t see much money available from pensions. We already have the annual and lifetime allowances to stop the rich from benefiting from them too much.
I’m not going to cry a river over cutting higher rate tax relief, I just think it would effectively end the point of pensions for that demographic. I would favour something more explicit such as bans on the richest using them, rather than effective bans through penal tax rates. Effective bans through penal tax-rates is how we ended up with the annuity requirement.
Thanks Simon for the correction.
It would be interesting to know what the take up of the Stakeholder (personal) pension has been. As I suggest the key component part of the policy Steve is suggesting is to get people on low incomes to make pension contributions.
Attending to Andrew’s point, I think that whilst it is relatively easy to make a decision, the challenge is creating the conditions in which such a decision could be implemented. I therefore think that a relatively small contribution from the state now may save it having to make larger payments in the future. This style of thinking was behind Gordon Browns Child Trust Fund scheme, obviously the challenge is that such long term investment is seen as a cost, whilst the paying out of greater sums of money is seen as an investment – we only need to compare the politics of the CTF and HS2 to see this dual standard of investment thinking in action.