Last year, following the Summer Budget, a green paper consultation on the taxation of pensions was launched. At the time, Chancellor George Osborne said he would announce the results of the consultation in his Spring Budget 2016.

But since then, speculations have been rife and a number of possible outcomes have been rumoured. Here we provide a summary of the changes Osborne is tipped to make next month and what the impacts of each could be.

Pensions ISA

The idea of an ISA-style pension, whereby upfront tax relief would be abolished, was initially toyed with by the Chancellor in his Summer Budget last year. If a pensions ISA were to be implemented, worker’s would pay tax today, rather than ‘tomorrow’ as they do now when they receive their pension.

However, many have claimed this method is effectively “stealing” from the next generation for the public services that are needed as society ages.

Former pensions minister Steve Webb has been particularly critical of this system, claiming it “steals billions of pounds” in tax revenues from the next generation. He also said if this announcement is made in March, then the Spring Budget could be “the biggest example of daylight robbery since the days of Dick Turpin”.

The Association of British Insurers has also been quick to warn of the problems associated with a pensions ISA. Based on research by the National Institute of Economic and Social Research, the ABI found that even if the government added up front 30 per cent to contributions, over 20 years a move to an ISA-style pension could result in an average annual reduction in contributions of £383.

Figures have found it could also cut average wages by £1,284 a year, increase the typical annual mortgage bill by £466 and reduce the size of the economy by around 6 per cent.

Despite this, a survey conducted by PwC found pension savers are more drawn to an ISA-style pension than the current tax relief system.

The survey, which quizzed 1,200 adults, found just over a quarter prefer the current pensions tax relief system, compared to four in 10 respondents who would prefer being taxed in a similar manner to that of ISAs.

The current pensions tax system provides pension tax relief on pension contributions made by the saver and their employer, and the pension is partially tax free at retirement. ISAs however, require savers to contribute out of post-tax income and any returns are tax free.

Flat-rate tax relief

Despite the possibility of a pensions ISA remaining firmly on the table, a recent report revealed the Treasury has been in the process of planning a more liberal swing towards a flat rate of tax relief.

According to the Financial Times, Chancellor George Osborne has announced intentions to move towards a more centre political ground by introducing a flat rate, which would remove the higher rate wealthier savers currently receive. He is now believed to be drawing up plans for a “hybrid” model with a flat rate that would be set between 25 and 33 per cent.

Accordingly, Osborne allegedly promised to make the Tories “the true workers’ party” by boosting tax relief for those on lower incomes while cutting it for higher earners. If it gains momentum, this policy could be a major landmark in political alignment.

If Osborne goes ahead with this policy shake-up, it would unusually resemble some of the policies featured in the Liberal Democrat manifesto last year – the introduction of a single rate of tax relief being one of them.

It is believed the government’s case for a reform to the tax relief system such as this is that it would be fitting to both political and fiscal necessities for the Chancellor and would allow some of the less affluent to really benefit from pension tax relief.

However, the flat rate has also been shunned by the industry as reports have shown a flat rate of 25 per cent would be worth little more than £2 per week extra for basic rate taxpayers.

Osborne was also accused of using the pension tax relief system as a “milch cow”, by raising more than £5bn in revenue if he were to cut the limit on tax-free contributions and the overall pension pot savers can receive.

Writing for The Times, Institute for Fiscal Studies (IFS) director Paul Johnson criticised the amount of changes made by the Chancellor as a way of increasing tax revenues through ‘milking’ people’s pension pots.

“If reports are to be believed it looks as if the current system of relief whereby income taxpayers get relief at their marginal rate, may be swept away in favour of a single flat rate of relief,” Johnson said.

“The dangers of fiddling further with tax relief like this are threefold. First, continued change makes planning more difficult. People will make mistakes or just give up on pensions.

“Second, there are likely to be unintended consequences. If it’s made more expensive to put money in a pension, yet more money in housing is a likely outcome.

“Third, with the government’s own figures suggesting that the majority of those under-saving for retirement are actually relatively high earners, the implicit contract at the heart of our pension system may buckle under the pressure. The cost of that would be high indeed.”

‘Tinkering’

If Osborne doesn’t make either of these two changes to the tax relief system, it has also been rumoured he is likely to ‘tinker’ with the system by making further detailed changes to the limits and structures of tax relief without fundamental reform.

However, Royal London has argued this would be the “worst of all worlds” as it would create “yet more uncertainty and complexity and missing a once-in-a-generation chance to simplify the system”.

“We need a reform which helps savers and offers simplification and stability, such as a generous flat rate of up-front relief combined with the abolition of the lifetime limit on pension saving. Anything else would be a huge missed opportunity,” the company’s director of policy Steve Webb said.

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