It is rumoured the UK Treasury has a small red box on the wall, with a glass lid inscribed ‘In case of Budget emergency, break glass’. Inside it keeps the UK’s pensions tax relief. With spending promises for the NHS and elsewhere to be honoured, the tax reliefs handed out to pension savers are once again under scrutiny. Contributor Tom McPhail, Head of policy – Hargreaves Lansdown.
Hammond has called out the pension system in his speech to the IMF conference (In Bali), so he’s obviously got a tax raid in mind. Here are a few thoughts on what the Chancellor could do to square the fiscal circle.
Possible targets for pension tax relief savings:
- Reduce the Annual Allowance for all pension savers
- Reduce the threshold at which the Tapered Annual Allowance is applied
- Apply the Tapered Annual Allowance more aggressively
- Reduce the Money Purchase Annual Allowance
- Increase the tax charge on pension funds on death
- Tweak the Annual Allowance or Lifetime Allowance valuation for final salary scheme benefits
- Scrap higher rate tax relief or move to a flat rate of relief
- Reduce the tax free lump sum allowance
- Restrict or abolish salary sacrifice
- Introduce a ‘Tobin Tax’ style transaction charge on pension funds
The considerations the Chancellor is likely to have in mind are: From a practical perspective, how easy would the change be to implement? From a political perspective, who would be upset and how upset would they be? From a fiscal perspective, how much money would it raise? From a pensions perspective, how much damage would it do to the long term retirement saving agenda?
Tom McPhail, Head of policy: “There are plenty of ways the Chancellor can raid our pensions to help balance his Budget. His ideal formula would be something which is easy to implement, doesn’t upset many people, raises lots of money and doesn’t seriously erode the long term retirement savings system.”
“The change which would potentially raise the most revenue is something targeted at the underlying assets in the pension system, similar to Gordon Brown’s infamous Advance Corporation Tax raid in 1997. There’s around £2.1 trillion in the pension system so even a very modest transaction charge of some description could raise serious revenue.”
“Unfortunately the mood music suggests the government is quite willing to carry on raiding from this country’s financial future to shore up the spending plans of today. Tax charges on the money people have put aside for their retirement solves a short-term problem, however it means a more impoverished retirement for millions in the future. This is not a pain-free solution and constant tinkering undermines investors’ confidence in the system.”
Reduce the Annual Allowance for all pension savers
Easy to do, mostly affects higher earners, would raise perhaps a few hundred million pounds, depending how low the Chancellor squeezed the allowance. If he cut it £35,000 many would see this as a bullet dodged; if he cut it to say £20,000 he’d upset an awful lot of people.
Reduce the Tapered Annual Allowance threshold
By design this is targeted at higher earners, effectively it only applies to those with incomes over £150,000. The Chancellor could cut this to perhaps £125,000 and there’d be little sympathy for the hundreds of thousands affected by it. Easy to do, politically attractive, it wouldn’t raise a huge amount but it would still be useful.
As an alternative, the Taper could be applied more aggressively; currently the Annual Allowance is removed at a rate of £1 of allowance for every £2 earned, meaning the Allowance is reduced to its minimum of £10,000 once someone’s income exceeds £210,000. This could be tweaked, for example so it applies at a rate of £2 lost for every £3 earned.
The Money Purchase Annual Allowance (MPAA)
Once someone has flexibly accessed their pension, they are limited to saving a maximum of £4,000 a year back into a pension. Cutting this further (it was originally a £10,000 allowance) flies in the face of changing work patterns, with people more likely today to move into retirement and back to work again as they grow older. Nevertheless, the Treasury has contemplated before the option of cutting the MPAA all the way back to £0. It would come at high political cost and probably wouldn’t raise big money, but desperate times call for desperate measures.
Pension fund death taxes
Generally speaking Tory ministers know better than hike up inheritance taxes. However we live in unusual times. The tax treatment of pension funds on death is inexplicably generous, with funds paid out tax free if the investor dies before age 75. Even if they die after age 75, there is still considerable scope for the recipients of any funds passed on to manage any subsequent withdrawals of the bequeathed funds in order to minimise any tax liability. This generous treatment may be distorting the retirement income market and encouraging investors to ‘hoard’ money in their pensions.
Pension Freedom has proved immensely popular. A modest tax charge on death, to apply in the future could bring in substantial revenue over time; it would however confirm everyone’s worst suspicions about untrustworthy politicians.
Final salary scheme calculations
For some reason, the Treasury persists in granting to defined benefit pension scheme members a set of rules which results in far more generous pension limits than those available to members of money purchase pension schemes.
For example, the test against the Lifetime Allowance is based on a calculation of 20:1, meaning a final salary pension of £10,000 a year is deemed to be worth £200,000 for the purpose of testing whether the member has exceeded the Lifetime Allowance. Here’s the rub though: someone with £200,000 in a Money Purchase pension scheme who wanted to draw a guaranteed inflation-linked income (similar to a final salary scheme), could only reasonably expect that £200,000 to pay an income of around £6,500 a year.
Any change to the rules would be practical to implement. However the principal losers of any change to these rules would be public sector workers, who can be a formidable political force when angered.
Scrap higher rate tax relief or move to a flat rate of relief
Big change which would upset lots of people including back-benchers, decision-makers in businesses and those aspiring to move into the higher wage brackets. Also technically complex to deliver due to the quirks of occupational scheme administration. The only arguments in favour of this radical solution are that it could raise quite a lot of money, and many agree the present system of paying the most tax relief to the highest earners looks, well a bit wrong really.
Reduce or scrap the tax free lump sum allowance
The tax free lump sum, usually 25% of accumulated pension savings, makes no sense. Except everyone loves it. Remove or reduce it at your peril. Many people will be relying on it for existing spending plans or to pay off their mortgage, so any curtailment would have to be introduced slowly and progressively. Which means it couldn’t raise much money in the short term. Any move to cut it would also do significant damage to investors’ confidence in the long-term stability of the pension system.
Salary sacrifice
At present it is a legitimate measure to ask your employer to reduce your salary and instead pay across additional employer contributions to the pension scheme. This means it isn’t treated as your pay and so no National Insurance is paid on this slice of your income.
This concession is tolerated by the Treasury but certainly not loved. Abolishing it would be quite complicated but most people don’t understand the mechanics of it and probably wouldn’t be very upset about it.
Tobin tax or some new tax on assets under administration
This is the big one. There’s over £2 trillion in the UK pension system so even some modest new Tobin tax style charge on trading activity could raise quite a lot of money quite quickly. What’s more most pension scheme members wouldn’t notice; their retirement savings would just grow a little more slowly. It would also steal John McDonnell’s thunder, which Hammond might quite enjoy,
