Pay on the way in, not on the way out? The government consults on possible ‘radical changes’ to pensions tax relief

In our recent blog about the budget, we mentioned the Government’s consultation on pensions tax relief.

The consultation notes factors influencing pension provision, for example increases in life expectancy and the related move away from DB and towards DC. It also notes all the changes the Government has made to encourage people to save for their retirement and provide a transparent and secure state pension. These include the introduction of automatic enrolment, the ‘triple lock guarantee’ on the state pension and, looking forwards, the introduction of a flat rate (and so easier to understand) state pension. Against this background, the Government is keen to “make sure that the system incentivises more people to take responsibility for their pension saving so that they are able to meet their aspirations in retirement”. However, it also considers the cost of pensions tax relief, the measures that have been taken in recent years (and announced in last week’s Budget) to control that growing cost and says that “it is vital that the system is sustainable”.

The paper invites views on a number of questions, including on options for reforming the system. It suggests that the options might range from radical reform to less fundamental changes. Radical reform might involve moving from the current system, where tax relief is given on contributions and investment returns but tax is paid on the end pension, to a model more like an ISA where contributions are taxed and topped up by the Government, but the end benefit is paid tax free. Less fundamental change might involve keeping the current system, but making further changes to the lifetime and annual allowance.

The Government acknowledges that “pensions tax-relief is a complex area which has wide-ranging implications for employers, the pensions industry and … pensions savers” and goes on to say that this is why “the government is approaching the consultation with an open mind, rather than putting forward a specific proposal for reform”.

The paper raises some timely and important questions. Successive changes mean that the ‘one size fits all’ approach to pensions tax heralded with tax simplification in 2006 has become difficult to explain and administer. As such, a simpler system would have its advantages. Greater transparency around tax relief (for example, a government contribution instead of tax relief) could also help savers to more easily see the benefit of the tax relief being provided by the Government. An ISA style model would also, of course, provide a more immediate ‘balancing payment’ to the Treasury. However a move to an ISA style model, with the end benefit being paid tax free, could increase the risk of people ‘spending out’ early in retirement. We await the outcome of the consultation with interest.