The existential threat to pension tax relief - the principal incentive for those saving for their retirement - returned this week.
MPs sitting on the influential Treasury Committee have recommended that the Government think again about pension tax relief, the system that links the tax relief on pension contributions to the rate of income tax that you pay. They also had something to say on pension saving limits, too.
The pension proposals featured on a long wish-list that was part of the Committee’s report ‘Household finances: income, saving and debt’. They sat alongside ideas on combating indebtedness and encouraging other types of saving.
In relation to pensions, the committee said: “…the Government should give serious consideration to replacing the lifetime allowance with a lower annual allowance, introducing a flat rate of relief, and promoting understanding of tax relief as a bonus or additional contribution.”
Changing tax relief on pensions would be dramatic and politically difficult. It could also potentially save the Government money, which is why the possibility keeps coming up. So far, successive Chancellors have stepped back from the change, sometimes despite making clear they would quite like to swing the axe. Many expected George Osborne to make the reform, having conducted a study into the fairness of tax relief. Philip Hammond, his successor, assessed but then rejected the change.
The argument against pension tax relief in its current form is well-rehearsed, and it was repeated by the Treasury Committee this week. ”There is widespread acknowledgement that tax relief is not an effective or well-targeted way of incentivising saving into pensions”, the MPs said.
At the moment, pension tax relief means that contributions benefit from money that would otherwise have gone to the tax man. Relief equivalent to any basic-rate tax paid is automatic, while the extra available to higher and additional rate payers is either added automatically or else claimed through a self-assessment tax return.
Contributions are allowed to build tax-free and then 25% of the pot can be taken with no tax due and income tax payable on the rest.
The biggest relative benefit comes for those whose income in retirement puts them in a lower tax band than was the case during their working life. And because the system is linked to the income tax you pay, it is more generous overall to higher earners.
This is the basis for objections to pension tax relief as it currently operates. Suggested reforms to the system include applying the same rate of tax relief to everyone, one that was higher than the basic rate but lower than the higher rate. An even more dramatic cut would lower it to just the basic rate.
This week’s report suggested a flat rate. Previous studies have suggested that this would be set at around 33% if change was to be cost neutral.
Does such a change have any chance of making it into law? At the moment these are simply recommendations to Government and the obstacles to them coming to pass are the same now as they have always been - the changes would be unpopular and uncertain to encourage more retirement saving.
It’s worth bearing in mind, however, that such changes tend to come without warning, for the good reason that giving notice that a tax perk is about to be removed tends to encourage widespread avoidance.
For the time being, higher-earning pension investors have an opportunity to take advantage of a system that may, sooner or later, close down to them.
Those planning their retirement could benefit from professional help. The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.pensionwise.gov.uk or over the telephone on 0800 138 3944.
Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Withdrawals from a pension product will not be possible until you reach age 55. Tax treatment depends on individual circumstances and all tax rules may change in the future. You should regularly reassess the suitability of your investments to ensure they continue to meet your attitude to risk and investment goals. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
Combining your pensions into a Self-Invested Personal Pension (SIPP) can make it easier to manage your savings - and it could be cheaper, with lower fees than you’re currently paying.