The government has said it wants to take a cross-party approach to difficult domestic reforms and, says Tom Selby, agreeing a sustainable way forward for pension tax relief would seem a sensible place to start
Just for a moment, the pensions industry breathed a huge sigh of relief as new Work and Pensions Secretary David Gauke appeared to all but rule out short-term changes to the pension tax system.
Speaking at an Association of British Insurers conference in London, Gauke said altering the pension tax relief system was already “daunting” and, given the weak position the Government finds itself in post-election, “fundamental” reform is highly unlikely in the near term. He also talked of the minority government looking to build consensus across party lines and adopt a longer-term approach to savings policy.
Unfortunately, as Cicero’s Iain Anderson pointed out after Gauke’s address, you cannot necessarily take politicians at their word and raiding the pension tax pot could yet prove irresistible as the Treasury looks at ways to raise cash.
Furthermore, by only distancing itself from “fundamental” reform in the short term, the government has left the door open to more tinkering at the edges. This will be all the more tempting as pressure mounts to ease pay constraints in the public sector.
Pension tax incentives have, however, already borne a significant burden of austerity over the past seven years. In fact, if you consider that in 2010 the lifetime allowance was pegged to inflation, in real terms it has pretty much been hacked in half. The inflation link is only due to return at the lower level of £1m in 2018.
While clearly £1m is a hefty pension pot, after tax-free cash it will buy a healthy 65-year-old a single life inflation-linked annuity worth just over £25,000 a year. That is already a significant constraint on tax-advantaged pension saving in defined contribution (DC) schemes and paring the allowance back any further would send a damaging anti-saving message.
If policymakers do turn their guns on pension tax relief, they should review the generous lifetime allowance factoring arrangements in place for defined benefit (DB) schemes, the main beneficiaries of which are civil servants and public sector workers.
Because of the way the lifetime allowance is calculated for DB, a 65-year-old who takes no tax-free cash might be entitled to an inflation-protected annual income – complete with 50% spouse’s pension – worth £50,000 a year. Twice as much, in other words, as the guaranteed income from the £1m allowance available to DC savers.
If short-term savings need to be made, policymakers could end this lifetime allowance apartheid. It is patently unfair that workers who have already benefited from gold standard pension provision are also handed significantly more generous tax perks.
Rather than looking at such issues in isolation, however, the government would do better to initiate a wide-scale, independent review of the pension tax framework – including tax allowances and the treatment of pensions on death.
This must not be a slash-and-burn exercise. As former CBI chief John Cridland – the man tasked with reviewing the state pension age in the UK – has observed, the ageing population is “as big an issue as climate change”. We therefore need to ensure any changes to savings incentives encourage more people to provide for their financial futures.
The government has said it wants to take a cross-party, collegiate approach to difficult domestic reforms. Setting about agreeing a sustainable way forward for pension tax relief would seem a sensible place to start.
Tom Selby is a senior analyst at AJ Bell
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