There is currently widespread speculation that the government is planning some form of tax raid on pensions in the forthcoming budget.
Here is what Hargreaves Lansdown hope won’t happen, what might happen and what should happen:
What won’t happen
Contribution tax relief
There will almost certainly not be any cut to the rate of tax relief granted to higher rate taxpayers on their contributions. Any move to restrict tax relief would be a tyre-screeching u-turn, given that this government only restored full tax relief a year ago. More pertinently though, politics is the art of the possible. The pension tax relief system is widely acknowledged to be imperfect, however any disconnect between the rate of tax an individual pays on their income and the rate of relief they receive on their pension contributions would result in an obscenely bureaucratic system to police it. No one who advocates a restriction to higher rate relief has yet come up with a credible way of achieving this goal whilst also keeping complexity down to an acceptable level. So unless the Treasury is really, really desperate for money, we don’t think this will happen (give us a call if you want the details on the complexity issue).
Tax free cash
There will almost certainly not be any restriction to the tax free lump sum payable at retirement. The government could impose a restriction on the amount of tax free cash paid out at retirement – usually 25% of the pension fund at present. If this were made retrospective, applying to existing accumulated pension funds, then it would be widely seen as a betrayal of investors’ trust and would have an immediate and significant negative impact on investors’ confidence in pensions. If it were to apply only to future accruals then it would not only create further bureaucracy (because of the need to distinguish between ‘old’ money and ‘new’), it would also fail to deliver any significant new revenue to the Treasury for many years to come. It would simply cause new problems without solving any existing ones.
What might happen
Restricting the annual allowance
The Treasury could cut the Annual Allowance. In April 2011 it was reduced from £255,000 to £50,000 as part of the trade off to reinstate full tax relief at investors’ marginal rates. The Treasury could now reduce the Annual Allowance further, from £50,000 down to £40,000 (for example). This might help to appease those who object to the tax relief benefits enjoyed by higher earners. Unlike other measures (see above) it would be simple. However it would also generate no more than a few hundred £ million at most. It would also have a negative effect on investors’ confidence in the pension system (see below). This has to be seen as the most likely cut to pensions as it doesn’t require any major revisions to the system.
What should happen
The government should leave pensions alone. Better still, it should give a commitment that it will leave pensions alone for at least the remainder of this parliament and it should call on the opposition to form a consensus that pension taxation is off the agenda for the next 10 years. This year marks the start of auto-enrolment. If it fails then there is no hope left for the UK’s retirement provision. Evidence is already available from New Zealand that political tinkering can and does undermine people’s trust in pensions and their willingness to save for the long term. The government should resist the temptation to treat pensions like an ATM, what we need is a period of stability.
Tom McPhail, Hargreaves Lansdown
Tags: acceptable level | accruals | betrayal | bureaucracy | bureaucratic system | desperate for money | forthcoming budget | lump sum | negative impact | old money | pension contributions | pension fund | pension funds | pension tax relief | pensions | rate taxpayers | restriction | retrospective | tax relief system | tyre