Tom Selby, head of retirement policy at AJ Bell, comments on the IFS report – ‘A blueprint for a better tax treatment of pensions’:
“The pension tax reforms set out by the IFS are balanced and well thought through. While often think-tanks will jump to radical proposals such as scrapping higher-rate pension tax relief in favour of a flat rate, the IFS rightly acknowledges this would create significant challenges, particularly for defined benefit (DB) schemes.
“Some of the ideas put forward here, in particular capping pensions tax-free cash, would be deeply controversial and risk a backlash of biblical proportions from voters. Others, such as making the tax treatment of pensions on death less generous, are potentially more doable but still come with challenges.
“The key, as the IFS acknowledges, is building a framework that is simple, provides savers with stability and maintains sufficient incentives necessary to ensure people save enough for later life.
“This need for stability is one of the reasons the idea of establishing a new pension tax commission, with a focus on simplification and encouraging more people to save for retirement, has appeal. Such a commission could potentially build the political consensus necessary to push through sensible, long-term reforms that can stand the test of time.”
Capping pension tax-free cash
“The ability to access 25% of your pension tax-free is one of the few parts of the retirement system that the majority of people both understand and value. As such, any move to remove or cap the available tax-free cash would risk undermining the fragile savings culture being built under automatic enrolment. It would also be deeply unpopular – a key factor given a general election is drawing near.
“It is far from clear how the transition from the current system to a reformed one would work in practice. Those who have bult up pensions under the existing system would, presumably, have any tax-free entitlement honoured if the UK were to shift to an alternative framework.
“This would inevitably mean creating a complex set of rules whereby those who have pensions already have that tax-free cash entitlement ringfenced, with new contributions moving to a different set of rules.
“It would therefore risk not only discouraging retirement saving but layering on additional complexity that would remain in the system for decades.”
Scrap tax-free death benefits of drawdown for deaths before age 75 and bring pensions into the scope of IHT
“The tax treatment of pensions on death is generous and, given how tight finances are at the Treasury, it would be no surprise if this came under the microscope.
“Under former Chancellor George Osborne the Government scrapped the controversial 55% ‘death tax’ on pensions. These new proposals from the IFS are not quite as pernicious, but come close to introducing a comparable penalty on death.
“Almost a decade on from Osborne’s reforms, the Government might be tempted to turn back time to help rake in a little more cash for the Treasury coffers.
“If there were to be reform in this area, one of the big questions would be whether those who have contributed to a pension or made spending decisions in retirement based on the current system would be protected. Without protection, the immediate moving of the tax goalposts would risk turning a sensible financial decision into one that costs people tens of thousands of pounds in tax. Those facing a colossal tax bill as a result of what would feel like a retrospective tax change would understandably feel extremely hard done by.
“However, creating a new protection regime – as we have seen when the lifetime allowance has been cut previously - would layer additional complexity onto an already difficult to navigate system and limit the amount of cash such a move would raise.
“Any move to levy a new pensions death tax would also be politically risky, and politicians would inevitably face a significant backlash from savers and retirees ahead of the general election.
“In terms of the financial decisions people make, the most obvious consequence of increasing taxation on death would encourage more people to spend their pension pots during their lifetime. As things stand, it can often be sensible to spend your non-pensions assets first in order to minimise the IHT your beneficiaries will pay on death.”
Scrap employer National Insurance relief on contributions
“If the Treasury is lining up pensions for a tax raid at the upcoming Budget, there is an argument levying National Insurance on employer contributions is one of the less painful ways to raise some much-needed cash.
“It would certainly be preferable to anything which undermines the retirement saving incentives of individuals, such as capping tax-free cash or ditching higher-rate relief.
“The big stumbling block here would be the extra cost it would load on businesses at a time when the UK is teetering on the brink of recession. Given the Government’s desperate desire to spur growth in any way possible, it seems unlikely an effective hike in businesses’ NI will gain much traction.”
Pensioners pay NI in retirement
“It is something of an anomaly of the UK tax system that pensioners do not pay National Insurance contributions. After all, older people are more likely to rely on public services like the NHS – so, theoretically at least, it would make sense for them to help fund those services by paying NI in the same way working people do.
“While the theory of charging NI on pension income might be sound, it is hard to imagine a situation, in the short-term at least, where a Government feels it can go down this road without sparking fury among older voters.
“Given the proximity to a general election, hiking NI for pensioners is probably towards the bottom of both Rishi Sunak and Keir Starmer’s current to-do lists.”
Splitting DB and DC lifetime limits
“The crisis engulfing the NHS has exposed the fact that the unintended consequences that can arise from a poorly designed system of tax allowances. Defined benefit and defined contribution pensions are fundamentally different, and so the idea of having a different framework for controlling each is sensible and merits more detailed exploration.
“Since ‘Pension Simplification’ in 2006, the UK pension tax system has become a mess of complexity. Any changes to lifetime limits would need to be focused on simplifying the rules and ensuring people have sufficient incentives to save for retirement.
“Similarly, the plethora of annual allowances that exist for different people depending on their circumstances is an absolute nightmare and undermines efforts to engage savers. If we can shift towards a world where there are a small number of easy-to-understand, sensible allowances, that would be a huge benefit to millions of savers and retirees.”
