Chancellor George Osborne could be set to introduce a pensions ISA, which would in turn deliver a tax “bombshell” by abolishing the tax free lump sum, according to former pensions minister Steve Webb.
Writing for the Sunday Times, Webb said Osborne is more likely to implement a pensions ISA than he is a flat rate of tax relief on pensions - a system he does not believe has ever been the Treasury’s “first preference”.
However, he warned savers would no longer be able to receive a tax free lump sum on cash as the money that would go into a pensions ISA would have already been taxed.
“Under the current system you can get tax relief on your pension contributions, enjoy tax-free growth in your pension fund and then take a quarter out tax-free — a hugely tax-advantaged way of saving. In effect, a quarter of the money in your pension never gets taxed at all under the current rules,” Webb said.
“With a pensions ISA, this tax break quietly disappears. Since all of the money that goes into a pensions Isa has already been taxed, there is no equivalent of the tax-free lump sum. Given that the break costs the chancellor around £4bn per year in lost revenue, it is easy to see why he might like to get rid of it.”
Reports have previously suggested the Treasury has been toying with the introduction of a flat rate of tax relief, which it claims would be 'fairer for all'.
However, Webb noted how in July 2015 when the chancellor published his green paper on the taxation system, the idea of a flat rate was "not mentioned at all".
"Instead, in his Budget speech, Osborne specifically floated an alternative idea, namely making saving for a pension more like saving in an Isa," Webb added.
"To the chancellor, the big attraction of the 'pensions Isa' is that he suddenly gets a tax windfall. For all of today’s workers who would have been deferring tax on their earnings by putting their money into a pension, the tax has to be paid right now, as soon as it is earned.
"It is true that they will pay no tax when they retire, but that is the problem of a future chancellor. In a sense, Osborne would be double dipping: benefiting both from the tax due on the pensions of today’s retired population as well as the tax due on the earnings of today’s workers, even though the latter are locking their money away in a pension."