Ready. Aim. Hold fire! Chancellor thinks twice before targeting pensions

First we had the controlled leaks to the press, presumably to test the public’s reactions; possibly a bit of calculated scaremongering to make the real plan seem less harsh – perhaps even some false leads to throw former pension ministers.

Whatever the motivations, one man must have been loving it: Gordon Brown.

Noisy hecklers are not always noted for pearls of wisdom, but three words from one – ‘Gordon Brown moment’ – seemed to bring sudden clarity to Tory MPs.

They seemed to realise that whichever way they looked at it, this was a highly charged issue likely to cause lasting damage, and the remaining image at the forefront of the public consciousness would be that of George Osborne.

Gordon Brown’s multi-billion pound tax raid on dividends would finally be replaced with a more vivid impression.

We may never know what the Treasury’s actual, radical plans were, but the reaction of Tory MPs, to my mind, backs my instinct: it was to take away 40% tax relief for middle earners.

All options seemed to be on the table, but there were arguably three big ones;

‘Tax-free cash‘, as the pension commencement lump sum is still popularly known, was simply too synonymous with pensions, too beloved by the public to be culled.

The ruse to tap into the public’s affinity for ISAs – and bring forward tax receipts in the process – by moving from EET to TEE (a translation* of which appears at the end) turned out to be too well understood and too thoroughly covered by the press, despite the apparent obscurity of the initials.

No, it is my belief that the real target was higher rate tax relief. Though the threat appears over, for now, it is well worth understanding the debate and the implications of this option.

It illuminates the value of pensions to ‘middle Britain’ and forearms us, should this option ever be revived again. Let’s not forget the choice of words – that ‘now is not the time’ – implying that later, it may be.

Do me a favour

The removal of higher rate tax relief had great potential to be spun as doing us a favour.

It must have seemed persuasive in Treasury debate on the options: tax relief does indeed go disproportionately to higher rate tax payers. However, this is no blank cheque.

With the annual allowance having been hacked back from £255,000 to £40,000 and with the imminent tapering of the annual allowance for those with ‘adjusted income’ (see box below) of over £150,000, the government has taken measures that are, in turn, reasonable and unnecessarily complicated to limit what is on offer.

A flat rate of tax relief in excess of 20% could be spun mercilessly as Tory help to the working man and woman, giving them more than just their 20% basic rate tax back and helping them save for retirement.

Indeed, governments of all colours will need that to happen, as the current ‘triple lock’ on the state pension is unsustainable.

However, it won’t work out like that in practice. The MPs knew it. Belatedly, the Treasury realised it. It is important that it is revealed to the public, too – especially ‘middle Britain’.

For millions on the lower rungs of the employment ladder, a flat rate of pension tax relief might as well be any number. When their bills are paid, there’s nothing left. They don’t save.

The people who will be hit hardest, if the Treasury divines a more opportune later time for the idea, are those not at the top of the earnings ladder, but those just high enough up to be 40% tax payers.

Once someone’s annual income currently exceeds £42,385, a doubling of the income tax rate from 20% to 40% makes such people the salmon of the tax system. Their key respite is 40% pension tax relief and for weighty numbers not far beyond the threshold, it’s the level of their earnings which limits their contributions and what the Treasury ‘gives away’.

To be sure, the current system has its flaws. But this measure does not solve them. That was never the aim.

There’s a gaping budget deficit to plug, and a turn on the prime ministerial throne at stake. The trouble is, the hit on the masses in the middle paying 40% would be too hard to go unnoticed and the scraps thrown to those just below too few (and locked away until retirement) to be appreciated.

I rather suspect the Chancellor’s moment of clarity came when he realised where this particular explosive issue would go off: among the 4.6 million higher rate taxpayers.

Their number has risen almost fivefold in the last three decades and they are concentrated at the beginning end of the scale. Now, who do you suppose they vote for?

Andy Leggett is head of business development for SIPPs at Barnett Waddingham

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