Calls for pension tax reform face mixed industry reaction

Proposals for the government to 'even-out' pensions tax support have received mixed reaction from the pensions industry, as experts warned that the reforms could bring unintended consequences and potentially disincentivise savers.

The Institute for Fiscal Studies (IFS) published a report today (6 February) outlining a number of reforms designed to boost the retirement income of low earners, whilst also reducing overly generous subsidies.

The call for a long-term view has been welcomed by industry experts, with Association of British Insurers (ABI) director of policy, long-term savings, health and protection, Yvonne Braun, agreeing that a long-term vision for pension tax relief is needed, rather than "constant tinkering".

"We also agree that up-front tax relief should be maintained, and consideration given to reforming the rules to offer more support to low and middle earners," she added.

However, Braun argued that it is "vital" that any reforms to pension tax relief aim to build long term stability and increase the trust savers have in pensions, emphasising that "any changes must be made for both defined contribution (DC) and defined benefit pensions, and in consultation with industry".

This was echoed by Pensions and Lifetime Savings Association (PLSA) director of policy and advocacy, Nigel Peaple, who stated that the proposed set of reforms include "both positive and negative elements".

In particular, Peaple raised concerns that applying taxation to employer national insurance contributions, even if replaced by a variable subsidy, might discourage employer pension payments.

"We believe that their suggested changes to the 25 per cent tax free lump sum would reduce a very popular and widely understood element of the pensions tax regime," he added.

Indeed, this proposal in particular has raised broader concerns, with Interactive Investor personal finance editor, Alice Guy, arguing that capping the tax-free amount you can withdraw from your pension would be a “serious disincentive” to pension savers.

She stated “The 25 per cent tax free pension incentive is one of the best well known and best-loved pension rules.

“Encouraging people to save more for retirement is a battle for hearts and minds and slashing one of the most popular pension benefits could have a chilling effect on pension saving.

"We need to preserve confidence in the pension system. Millions of pension savers have built up pots under the current system and some could end up paying tax twice on the same pension savings, with the proposed changes.

“There’s also a danger that widespread pension reform creates confusion and gives the impression that pensions are complicated and not for everyone.”

Adding to this, AJ Bell head of retirement policy, Tom Selby, warned that capping pensions tax-free cash could be "deeply controversial and risk a backlash of biblical proportions from voters", which could be a key factor given a general election is drawing near.

Selby also argued that it is "far from clear" how the transition from the current system to a reformed one would work in practice, suggesting that this could mean creating a "complex set of rules" whereby those who have pensions already have that tax-free cash entitlement ringfenced, with new contributions moving to a different set of rules.

“It would therefore risk not only discouraging retirement saving but layering on additional complexity that would remain in the system for decades," he stated.

Evelyn Partners managing director, Jason Hollands, also raised concerns over the potential implementation of such a proposal, explaining that many savers may have already planned to use their tax-free lump sum for a specific purpose, such as paying off a mortgage.

"Were such a policy to be implemented relatively quickly, it could leave retirement plans in a very difficult place," he stated.

However Quilter head of retirement policy, Jon Greer, Greer argued that whilst restricting tax-free cash is "emotive and always has been", individuals would only save "significant tax revenue if the change was applied to existing pension savings and that runs against the usual transitional protection that the Treasury usually apply".

He continued: "If government applied it retrospectively there would be such a backlash that the Conservatives would unlikely be re-elected for some time.

"You could even go as far to suggest that the government might be subject to claims of human rights infringements. People would likely feel that an unwritten pact had been broken and it could seriously damage the reputation of pensions."

More broadly, Greer also argued that while the proposals will "almost certainly elicit some consternation from the industry and public", they "certainly take pension taxation in a different direction and this should be welcomed".

In particular, Greer highlighted the idea of consigning flat rate relief to the 'ideas bin' as one good thing set out in the report, arguing that flat rate relief is a "big headache" for net pay arrangements to implement as well as for HMRC and issues around salary sacrifice."

He added: "Ultimately changing the current regime isn’t easy because there is no silver bullet to fix all the problems but radical ideas are never easy to stomach and while many of the proposals may have some tricky practical application and perhaps some unintended consequences we need to have these conversations as they move the debate forward on an issue that will have a profound impact on the fortunes of the generations to come."

Selby also described the IFS reforms as "balanced and well thought through", stating that whilst some ideas will be controversial, others, such as making the tax treatment of pensions on death less generous, while still presenting challenges, are "potentially more doable".

“The key, as the IFS acknowledges, is building a framework that is simple, provides savers with stability and maintains sufficient incentives necessary to ensure people save enough for later life," he stated.

“This need for stability is one of the reasons the idea of establishing a new pension tax commission, with a focus on simplification and encouraging more people to save for retirement, has appeal.

"Such a commission could potentially build the political consensus necessary to push through sensible, long-term reforms that can stand the test of time.”

Scottish Widows head of pensions, Pete Glancy, also welcomed the desire to simplify the complex system of pension tax allowances, highlighting the potential positives for DC savers in particular.

“The proposal for a ‘lifetime contribution cap’ applying to DC pensions would be a solid starting point for discussion as it would limit the amount of tax relief from which wealthy savers could benefit during their working lives, but after that pension pots could grow naturally and be invested in a less constrained way," he stated.

“This would give DC savers the highest level of pension income as well as highest level of tax receipts to the Exchequer in the longer term.”

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