In 2006 the previous government introduced what it described as ‘pension simplification’, a radical reworking of the pension tax rules. Ever since, there has been a process which has now gained the label of ‘complification’ – adding complexity back into the pension tax system. The current government can take a fair slice of the blame, with its efforts to cut back the cost of tax relief by twice reducing both the lifetime allowance (on total benefits) and the annual allowance (on contributions).
A recent paper from the Pension Policy Institute (PPI) examined who benefits from the current pension regime and highlighted two tax points:
- Basic rate taxpayers are estimated to make 50% of the total pension contributions, but benefit from only 30% of pension tax relief. In contrast, 50% of all pension tax relief goes to higher rate taxpayers, with the balance going to additional rate taxpayers, while these groups make 40% and 10% of the total contributions respectively.
- Currently 77% of pension lump sums by number are under £40,000, but these account for just under a quarter of the tax relief on lump sums. At the opposite end of the scale 2% of lump sums are worth £150,000 or more and they attract nearly a third of tax relief on lump sums.
The PPI’s concluded that instead of marginal rate income tax relief, a flat rate relief of 30% for everyone would be better at incentivising low and middle income earners and spreading the benefit of tax relief more evenly. It looked at a number of options for cutting back on the lump sum, but concluded that these would have limited immediate effect because any change could not be made retrospectively.
The PPI’s ideas on flat rate relief should not be dismissed as just the musings of another think tank. They echo proposals from the Centre for Policy Studies, a think tank founded by Sir Keith Joseph and closely linked to the Conservatives. The other main political parties have both talked about cutting tax relief for high earners, so the writing may well be on the post-election wall.