Proposals in 'a blueprint for a better tax treatment of pensions', bring risk of unintended consequences.
interactive investor comments on the Institute for Fiscal Studies (IFS) pension report: a blueprint for a better tax treatment of pensions, looking at the proposals in detail, as well as potential impact.
interactive investor, the UK’s second-largest investment platform for private investors, wants to see a nation where everyone is supported to build financial resilience in retirement.
The favourable tax treatment of pensions has long been under scrutiny, and it is so again in today’s report. But interactive investor believes that the favourable tax treatment available in pensions needs to be preserved and protected if we are going to encourage a nation of pension savers.
Today’s proposals bring risk of unintended consequences.
Alice Guy, Personal Finance Editor, interactive investor, says: “Capping the tax-free amount you can withdraw from your pension would be a serious disincentive to pension savers. The 25% tax-free pension incentive is one of the best well-known and best loved pension rules. Encouraging people to save more for retirement is a battle for hearts and minds and slashing one of the most popular pension benefits could have a chilling effect on pension saving.”
Barriers to saving
One of the most striking barriers to growing retirement provision, interactive investor believes, is a lack of confidence and knowledge.
Retirement outcomes are being routinely compromised by just ‘not knowing’. Nearly one in four (24%) of the general population say they know nothing about pensions, according to ii’s Great British Retirement Survey of 10,000 UK adults. The proportion is even greater in lower-income households (32%) and higher for women (29%) than for men (18%).
In a world of pension freedoms, and after 10 years of auto-enrolment, this feels like policy failure. interactive investor believes that a radical overhaul of the tax system could create more confusion and more disincentives, at a time when trust in pensions is in danger of withering on the vine as the state pension age continues to climb.
Alice Guy, Personal Finance Editor, interactive investor, says: “We need to preserve confidence in the pension system. Millions of pension savers have built up pots under the current system and some could end up paying tax twice on the same pension savings, with the proposed changes.
“Saving for retirement is a marathon, not a sprint, and people take years to save enough for a comfortable retirement. Changing the rules half-way through is unfair on those who’ve saved on the basis on the current system. It means millions of Brits will suddenly need to save more for their retirement and their pension pot won’t stretch as far as they expected.
“There’s also a danger that widespread pension reform creates confusion and gives the impression that pensions are complicated and not for everyone.”
Charge NI on pension income
Alice Guy continues: “Introducing National Insurance on pension income would be a huge blow for millions of pensioners and reduce their income significantly. At the moment, people over state pension age don’t have to pay National Insurance, making their income stretch just a little bit further in retirement.
“A pensioner with an annual income of £20,000 currently receives £1,542 per month after tax, but this would reduce to £1,468, per month if National Insurance was charged. This is a drop in post-tax annual income of £74 per month and £888 per year.
“Charging NI on pension income is also unfair on older workers as introducing National Insurance on pension income means that some people will be paying tax twice if they built up their pension pot under the current system. They paid National Insurance on pension contributions and, under the proposals, they will also end up paying it on pension income once they retire. Someone contributing £200 to their pension pot for 40 years would end up paying £11,500 in National Insurance on their pension contributions during their working life and then pay National Insurance again when they come to draw a pension.”
Employers NI applied to pension contributions
Alice Guy adds: “Charging NI on employer’s pension contributions will increase the tax burden on businesses significantly at a time many can ill afford it. The proposed changes come at a time when small businesses are already struggling with spiralling energy, staff and transport costs. Employers currently pay National Insurance of 13.8% which is an extra cost on top of wages.”
Make the lifetime allowance more generous
Alice Guy adds: “The lifetime allowance has more than halved in real terms since it was introduced in 2006. Like many complex pension rules, the lifetime allowance has a chilling effect on pension saving and creates the impression that pensions are complicated and confusing. The current rules also favour workers on defined benefit pensions as they can achieve a higher pension income before hitting the lifetime allowance.”
NI relief on pension contributions
Alice Guy adds: “Waiving National Insurance on pension contributions will make pension tax relief even more valuable for pension savers, boosting pension contributions by an extra 12% for basic-rate taxpayers and 2% for higher-rate taxpayers, increasing pension tax relief to 32% for basic-rate taxpayers (20% income tax plus 12% National Insurance).
“The proposed change would mean that a £100 pension contribution would only cost a basic-rate taxpayer £68, compared to £80 under the current system. This would make it easier for lower earners to build up enough for a decent retirement and could add £32,187 to the pension pot of someone saving into a pension for 40 years (assuming a pension contribution of £200 per month, investment growth of 5% and fees of 0.5%).”
Make annual pension allowance more generous and end taper for higher earners
Alice Guy says: “Making the annual pension allowance more generous would be great news for pension savers, especially those who are trying to make up for lost time and boost their pension pot before retirement.
“However, the proposals don’t touch on the money purchase annual allowance, which caps pension contributions at £4,000 per year for workers who start drawing an income from their pension and later return to work. This low limit unfairly penalises older workers who may have taken time out due to ill-health or to care for a loved one. It’s important to recognise that the one-job-for-life type of career is largely in the past. We need flexible pension rules to give older workers who return to the workplace the chance to save enough for retirement.”
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