On 16 March, Osborne is expected to turn the current system of pension tax relief on its head.
Under the current regime, pension contributions and investment returns are tax-exempt and only income drawdown is taxed at the individual rate – 20%, 40% or 45%.
The two most likely options being mooted are either a flat rate scheme – seen as beneficial to low earners but as a tax hike for those earning more than £150,000 ($211,450, €194,120). Or a ‘pension Isa’, whereby pension contributions are taxed and both interest and any future income streams are tax-free.
Tom McPhail, head of retirement policy at Hargreaves Lansdown said the chancellor was leaning towards an Isa-style system despite pressure to the contrary from the pensions industry, prime minister and key members of his own cabinet.
Altmann speaks out
The Financial Times reported on Friday that the pensions minister, Baroness Ros Altmann, has spoken out against reform that would reverse the taxation of pensions from EET – exempt (contributions), exempt (earnings), taxed (income), to TEE – taxed, exempt, exempt.
According to the FT, Altmann said: “The freedom and choice reforms have put us in a place where people’s pensions can work well for them. However, tax is a natural brake on them spending their pension fund too soon.”
She added: “It’s clear the current system offers very good incentives to higher earners but is also clear that those who are not higher earners may need more incentives.
“We may decide that the current system is best. It has got some merits.”
The other option under consideration is a flat rate of tax relief, which would encourage more low earners to save because their tax relief would increase.
Cost savings eyed
With net annual costs of pension tax relief estimated as more than £21bn, the government launched its consultation period last year.
McPhail said the proposals might save the Exchequer some money in the short term but at the expense of the UK’s long-term savings objectives.
“There are a number of reasons why this proposed solution is likely to run into difficulties,’ he said.
“An Isa-style reform with tax relief being scrapped in favour of tax-free withdrawals would create the risk of a future Northern Rock-style run on the pension system and the UK stock market.
“Any hint of political interference in the future could result in billions of pounds being withdrawn overnight; it would be hugely unstable.”
He said the suggestion of a 20% top-up – in addition to a tax-free lump sum – looked attractive on first glance but stressed any changes to the system will result in cuts to any tax relief available down the line.
“This is likely to be particularly bad news for anyone who becomes a higher rate taxpayer towards the end of their working careers when they are most able to catch up on their pension funding.”