The Problem with Abolishing UK Pensions Tax Relief
It seems increasingly likely that the budget in April will be looking to introduce changes to pension taxation, with the smart money being on changes and maybe the abolition of tax relief on pension contributions. The financial press has been full of articles arguing whether this is a good or bad thing, and whether this is a necessary change or just more legislation.
It is undeniable that the cost of pension tax relief is one of the larger burdens assumed by the treasury. In 2014, the gross pension tax relief on contributions and investment growth for both personal and occupational pensions was £34.3 billion. This was offset by a £13.1 billion receipt of tax on pensions currently in payment. That is a lot of money tempting a chancellor in need of funds. It is certainly conceivable that the chancellor will simply reduce and abolish tax relief without looking to replace it.
An article published in 2012 by Michael Johnson of The Centre for Policy Studies stated a strong argument for changes to tax relief, positioning nine proposals for a new model of tax relief. The most interesting was the proposal to introduce a single flat rate relief of 25%. This year, the alternatives to the existing tax relief system seem to have settled into two clear camps: the pension ISA model as proposed in the summer budget (whereby contributors would not receive tax relief on contributions, but would on savings or investments), and the flat rate scheme as proposed by Johnson. This later proposal has gained popular support, with the likes of Aviva and Hargreaves Landsdown both publicly backing it.
Whatever happens in April, one thing is clear: even after the advent of auto-enrolment and the introduction of Pensions Freedoms, there are still significant numbers of people in the UK not contributing or covered by a pension. The removal of tax incentives, without an alternative replacement, will simply disincentive an already reluctant population from further pensions engagement.
For the average saver, the attraction of easily accessible funds through ISAs or other investment products will far outweigh the locked-in nature of pensions, leaving greater numbers of people with insufficient pension income in retirement (the more flexible Australian superannuation model, whereby funds can be drawn down early for special events, is currently struggling with a funding crisis).
Regardless of which alternative is the most prudent, the risk of further alienating UK pensions savers with a full abolishment of tax relief is too great to take.