The pensions industry has welcomed the wide ranging consultation on pensions tax relief launched today, but warned of the dangers of conflating pensions and ISAs.
Although it is less than a decade since the last tax simplification, commentators said an overhaul of the current system was long overdue.
The consultation, which was announced in the Chancellor's summer Budget, asks whether the complexity of the current system puts people off saving and looks at a broad range of possible solutions.
In his Budget speech, George Osborne said one option was to scrap up front tax relief and but exempt pension investments and benefits from taxation.
Turning tax on its head
PwC pensions partner Peter McDonald says the tax treatment of pensions has got "out of hand" in recent years and is overly complicated.
He says: "Continual changes have undermined confidence in pensions and this is a great chance to re-build that trust by overhauling how pensions are taxed once and for all. This could help address the fairness of tax relief for those members earning defined contribution versus defined benefit pensions."
But McDonald warns that moving away from upfront tax relief could prove a hard sell.
"Turning taxation on its head, while convenient from a fiscal perspective, is really hard to communicate to consumers," he explains. "Especially those coming into auto enrolment for the first time, who often don't have the support of employers' with long pensions history themselves."
But Pinsent Masons partner Alastair Meeks says taxing pensions on the same basis as ISAs could prove very tempting for the government.
"This would have three effects," he says. "1) It would effectively remove the tax advantages of the tax free lump sum; 2) It would take higher rate tax relief away from all higher rate taxpayers but only give tax relief at that rate to those of them whose pensions would also be taxed at the higher rate; and 3) It would accelerate the receipts of tax.
"Perhaps none of these have crossed George Osborne's mind, but it does seem like a happy coincidence that this is being floated in an austerity budget."
Many industry figures have warned about the dangers of conflating pension schemes and ISAs, however. Buck Consultants head of trustee services David Piltz says: "The proposed consultation could of course blur the lines between ISAs and pensions still further - raising real questions on how we are going to ensure people use their long-term savings to provide for their retirement."
Ironing out the lumps
KPMG partner Mike Smedley says incentives for long-term savings need to be better than for short-term savings under a new system. He also points out that making all benefits tax free would make tax free lump sums a thing of the past.
PwC's McDonald says would present a major challenge for pension supporters, especially if the tax-free lump sum was to be removed for contributions already made.
McDonald adds that the government has implicitly raised the question of whether sponsors of defined benefit schemes should qualify for tax relief on deficit recovery contributions.
"This could have a major impact on employers' willingness to engage in supporting sustainable long-term savings of any kind," he says.
"The public sector is not mentioned explicitly but as the largest area of continued defined benefit cost, one wonders whether the green paper will focus on the tax cost of these to the country?"
But many commentators see the consultation as a chance to establish a new consensus on a subject that has proved contentious in recent years. Successive governments have been criticised for tinkering with the workings and levels of the annual and lifetime allowances.
Investment Association chief executive Daniel Godfrey says: "This consultation represents a real chance to sort out pensions once and for all. It comes at a crucial time, with speculation about the cost and distribution of pensions tax relief creating damaging uncertainty.
"Citizens need long-term certainty on pensions to give them the confidence they need to commit their hard-earned savings to the long-term investment needed to provide for their futures.
"This means stable, simple and easy-to-understand tax incentives for long-term saving that are affordable for the Nation. It also means simple, transparent and value-for-money products to help them succeed in achieving their financial objectives."
Godfrey says this means cross-party support is essential, and that the government must be radical where necessary.
He says: "If we get this right, we can create stable and effective tax incentives for retirement saving that enable people to save with confidence for their security and comfort in the future."
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