Fix pension tax system 'distortions' - OTS

The Office of Tax Simplification (OTS) has recommended that the government reviews a series of complex pension tax measures, which it says are so complicated that they are creating unfair “distortions” for savers.

In a new paper called OTS Life Events review: Simplifying tax for individuals, the OTS highlighted the complexities of pension tax rules and called for them to be changed.

The tapered annual allowance, as well as the combined effects of annual and lifetime limits are criticised in the report. It says that these limits should be reviewed to take account of the distortions they “sometimes produce”.

“In recent years the government has reduced the overall level of tax relief available for pension saving, in particular through the annual allowance and lifetime allowances,” says the report. “The way these work is complex and, in certain situations, can lead to disproportionate outcomes.

“The OTS recommends that HMRC ensure clear guidance on the tax issues is available, and that the government continue to review the allowances taking account of the distortions they sometimes produce.”

At the same time, the OTS has urged the Treasury to look at pension tax relief.

It points out that current rules have resulted in many lower paid workers missing out on pension tax relief altogether if their employer uses a ‘net pay’ mechanism to provide them with a pension.

It says that the use of ‘net pay’ and ‘relief at source’ arrangements should be altered so that the difference in outcomes for savers is removed, or at least reduced.

In addition, the OTS has urged the government to examine the administrative arrangements surrounding the high income child benefit charge, as they can adversely affect people’s state pension.

The charge is applied where an individual or their partner receives child benefit and one of them has an income over £50,000 a year.

It gradually takes back a proportion of the child benefit, up to a £60,000 threshold, after which the full amount of child benefit is retrieved by the state.

“Some people avoid the complexities of tax reporting by not claiming child benefit,” says the paper.

“However, this can mean they lose out on national insurance credits towards the state pension, and their son or daughter will not automatically receive a national insurance number as they turn 16, which can mean they won’t pay the right amount of tax until they are able to arrange to get one.

“These problems can be sidestepped by first making a child benefit claim, but then choosing not to receive payment of it.”

The pensions industry has broadly welcomed the paper, with AJ Bell senior analyst, Tom Selby, saying that it has laid bare “the nightmarish complexity” that savers experience in the UK pension tax system.

“It is frankly bizarre that savers now have to get their heads round an annual allowance, money purchase annual allowance, tapered annual allowance and lifetime allowance, all of which could apply to people at different stages of their life,” he said.

“Some of these measures have serious consequences. The taper, for example, is placing huge strain on the NHS as senior doctors are forced to refuse extra shifts to avoid eye-watering tax bills. The MPAA, which is poorly understood, severely punishes those using the pension freedoms, reducing their annual allowance from £40,000 to just £4,000.

“We know this complexity puts people off pensions and the government now needs to put simplification at the heart of its savings agenda.”

He added that policymakers needed to convene a commission tasked with simplifying the system and encouraging more people to save for retirement.

However, Royal London director of policy, Steve Webb has questioned as to whether HMRC will even pay any attention to the report’s recommendations.

“This report by the highly respected and independent OTS makes a great deal of sense,” he said.

“It has highlighted several areas where the tax system causes complexity and unfairness for ordinary taxpayers.

"Ideally, the government would listen carefully to this report and make changes. But in the past, HMRC has treated OTS recommendations with contempt, ‘marking their own homework’ and deciding that nothing needs to change.

"I hope that this time the watchdog will have some teeth and the government will listen”.

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