While the PLSA is clear it does not want any fundamental change to pensions tax relief in this year’s budget, there is increasing talk that the Autumn Budget might herald substantial change. Jonathan Stapleton looks at the best options for reform should it have to occur.
Rumours abound that the government would like to cut pensions tax relief to meet the costs of building back better post-pandemic in lots of areas, including social care.
At its annual conference on 13 October, a Pensions and Lifetime Savings Association (PLSA) panel looked at different ways the government might raise £5bn a year from pensions and the consequences these reforms might have on pension saving.
PLSA policy board member and Lane Clark and Peacock (LCP) head of defined contribution (DC) Laura Myers said any of the main reforms currently touted (see below) would be "hard options" - with none meeting all of the PLSA's Five Principles for Pensions Taxation.
The principles are that any reform should: promote adequacy; encourage the right behaviours; be fair to all; be simple to adopt and administer; and be enduring and sustainable.
Myers said even her preferred option of a flat rate was flawed - being both "horrendously complex for defined benefit" and one that would only raise an estimated £600m per year for HM Treasury.
She explained: "The best you would get is two ticks [out of five] - reform is really incredibly hard."
Areas of generosity
Institute for Fiscal Studies deputy director Carl Emmerson felt that, when looking at the pensions tax regime, it was important to look at areas where the current system was more generous than a neutral ‘exempt, exempt, taxed (EET)' regime.
He said this analysis showed there were three places where the current system looks more generous than neutral.
First, Emmerson asked if the current tax-free lump sum of 25% was well targeted - noting that putting some sort of a cap on the size of this lump sum would seem fairer.
Second, he said that employer contributions to pensions currently escape National Insurance (NI) contributions entirely - a state of affairs he described as both "extremely generous" and "opaque". He added that, in addition, no NI contributions were levied on pensions income either.
He felt this was increasingly out of kilter with a government that continued to raise NI and questioned why the new health and social care levy wasn't being applied to pension income.
Emmerson said: "There is a strong case for some NI contributions being levied, either on employer pension contributions or on pensions income in receipt.
He said the total quantum of employer NI relief was £11bn a year and every 1% levied on pensions income in receipt would raise £650m a year.
Finally, Emmerson said the current treatment of pension pots that are bequeathed - where, for instance, individuals who die before age 75 can pass on their entire pot without any income tax or inheritance tax liability - was "indefensibly generous".
Pensions Policy Institute director Chris Curry said he thought £5bn was an "awful lot of money to raise purely from pensions" - questioning the need to raise so much from just one thing.
He said: "Pensions are all about balance and trade-offs - there are always decisions to be made; always advantages and disadvantages of certain options; and always winners and losers.
"To my mind, if you are trying to take £5bn out of a system, it is hard to create winners, all you are going to do is create losers.
Despite this, Curry said one area the government might look at was the state pension. He said the recent changes to this - where the government temporarily suspended the average earning component of the triple lock, replacing it with a double lock linked to either inflation or 2.5% in 2022/23 - could be a starting point.
He said this reform alone would save £5bn next year and other alternatives, such as replacing the average earning component with one that was smoothed over two years could save £2bn a year if implemented.
However, Curry believed a more considered approach to tax reform was needed. He said: "What you would want to look at is what we want the pensions system to achieve, how can we best afford it, and then try and make sure you can implement it in the most cost-effective way."
The tax body's figures - published on 30 September - revealed the gross cost of pensions tax relief hit £41.3bn in 2019/20, up from £38.2bn the year prior.
The figures also showed that tax paid on pension incomes increased from £18.7bn to £19.2bn over the same period.
HMRC said, when tax on pension incomes was taken into account, the net cost of pensions tax relief in 2019/2020 was £22.1bn - around £2.6bn higher than the 2018/19 figure.
In September, the PLSA urged the government not to make any fundamental changes to pensions tax relief as part of its forthcoming Autumn Budget on 27 October.
The PLSA said it does not believe now is the right time for a fundamental reform of pensions tax relief - warning that many people are not saving enough for their retirement and tax relief acts as an important incentive to help people save.
Despite this, the PLSA did call on the government to consider resolving the net pay and relief at source anomaly - the ongoing tax administration issue that results in approximately 1.5 million lower earners in net pay schemes missing out on pensions tax relief.
It said it continues to believe that a central solution - the so-called P800 process, operated by HMRC - would deliver the sort of comprehensive, efficient, cost-effective solution it believes is necessary and require no further engagement from savers.