Higher rate tax relief and salary sacrifice should be abolished and pension and Isa annual contribution limits should be a combined £40,000, says influential pensions expert Michael Johnson.
In a Centre for Policy Studies paper, Johnson has called for the government to take on ‘deeply-entrenched vested interests’ in the financial services industry by abolishing higher rate tax relief. Part of the £7bn annual saving could then be used to reinstate the 10p tax rebate on pension assets’ dividend and interest income, which would cost £4bn a year.
Salary sacrifice meanwhile should be abolished because it is ‘essentially a tax arbitrage scheme at the Treasury’s expense’, says Johnson.
The paper comes as speculation grows that higher rate tax relief could be reduced in the Budget later this month. Individuals would be allowed to save up to £40,000 a year either in an Isa or a pension under Johnson’s plan, with the Treasury adjusting the limit each year in the Budget depending on affordability. The increased Isa limit is designed to appeal to savers turned off by the long-term nature of pension saving. Isa is still a trusted brand, he argues.
Johnson is also proposing replacing the 25 per cent tax-free concession on lump sum withdrawals at retirement with a 5 per cent “top-up” of the pension pot, paid prior to annuitisation, which he argues would be of much more lasting benefit, to most people. This change would be cost-neutral, he argues.
Johnson says the 2010 £21.1bn tax relief on employee contributions and £8.3bn NI rebates on employer contributions amounts to three quarters of the UK defence budget and is 23 per cent more than the government spends on transport. He argues that tax relief is not achieving its goal of reducing pensioner poverty because half of it is currently going to the 8 per cent of taxpayers earning £50,000 a year or more.
He argues that despite supporters of higher rate relief claiming that tax is merely being deferred, this is not the case. Instead, he argues, the Treasury is effectively co-investing with recipients of higher rate relief, anticipating repayment through post-retirement income tax. But because only one in seven of those who pay higher rate tax whilst working go on to pay higher rate tax in retirement, the Treasury loses out.
Johnson says: “At nearly £30 billion per year, the Treasury’s spend on incentivising retirement saving dwarfs the budgets of many Departments of State.
“Today’s tax-based incentives to save for retirement are hugely expensive and, worse, ineffectively deployed. Skewed towards the wealthy, they do far less than they should to minimise pensioner poverty. Furthermore, they do little to catalyse a savings culture amongst younger workers, thereby exacerbating the looming generational inequality.
The savings incentives framework should be restructured, which will require a preparedness to confront deeply- entrenched vested interests within the savings industry. “Salary sacrifice schemes are essentially a tax arbitrage at the Treasury’s expense. As such, they should be banned.”