Pensions tax relief under scrutiny

Some of the main reasons that the Treasury want to look at the taxation of pensions is that people are living longer; they’ll require more money in their old age; and the shape of the pensions market is changing. Although various reforms, such as the new state pension, automatic enrolment and pension freedoms have been made, there is a concern that the current EET system might need to be changed to encourage more people to save more.  In addition, there is the small matter of the £50 billion or so that the government forwent in tax and national insurance relief in 2013-20141

There is a general feeling that people like ISAs more than pensions as people are more likely to understand them. This might be due to the perceived complexity of pensions, a mistrust of the industry, the decline of defined benefit schemes, or a combination of all of these. As a result, one option for reform is to turn the current system on its head and make it TEE (taxed, exempt, exempt) instead, just like ISAs. It’s suggested in the consultation paper that this would come with a government top up. For example in New Zealand, people in the Kiwisaver (a distant cousin of automatic enrolment, and incidentally ETE) get 50 cents for every dollar saved, up to a maximum of $521.43 per annum (they also used to get $1,000 up front until it was scrapped in May this year)2. Compared to what we have just now, a TEE system would presumably save the government money in the form of tax and NIC receipts but would cost money in the form of some sort of incentive. Of course the government would also lose the tax receipts from benefits in payment so that would have to be taken into account as well. One potential issue with this system is that we would need some sort of guarantee that a future government wouldn’t change the system to TET (taxed, exempt, taxed) or even TTT! (taxed, taxed, taxed). Perhaps the most difficult aspect of changing the system so drastically would be the necessary transitional arrangements.  Would a new system only apply to people who start saving past a certain date? If not, what about those who have saved under both systems.  Could this mean you recieve part of your benefits tax free and the rest taxed? Or will their be a cut off date where any tax relief already given will be deducted from people’s pension pots?

Another option could be to keep the current EET system but to introduce a flat rate of tax relief on contributions at around 30%. This would arguably cause less disruption to the systems and processes in place and help address the fairness question where higher earners appear to be getting the lion’s share of tax relief. 

What’s perhaps encouraging about this consultation is that it is a consultation.  It gives us all a chance to inform the Treasury as to how (or if) things need to change so that we can build a sustainable, efficient pension system going forward.

1 – ‘HM Treasury, Strengthening the incentive to save: a consultation on pensions tax relief’ Page 15, para 2.7

2 –