The Big Question: Should pensions tax relief be removed to create a flat society?

This question sparked off a heated debate at the Employee Benefits Pensions Summit 2011. Two of the fiercest debaters elaborate on their opposing views. Express your view here.

Michael Johnson, research fellow at the Centre for Policy Studies:

Up-front tax relief on pension contributions costs some £30 billion a year, paid predominantly to the wealthy (they do, after all, pay the most tax). But given the size of this cost, Treasury ministers should occasionally ask themselves the key question: what is the purpose of tax relief? If they were to conclude that it is primarily to incentivise long-term saving, leading to less pensioner poverty in the future (rather than being part of a complex mechanism to compensate higher- and additional-rate taxpayers), then why not simply redirect the £30 billion to boosting the basic state pension (£50.5 billion last year) by some 60%?

Such an approach certainly has the virtue of simplicity, and it would catalyse a virtuous circle. By lifting the basic state pension above the means-testing threshold, the cost of pension credit (£8.3 billion last year) would diminish, releasing additional funds to be redeployed into a still higher British state pension. Additional savings could be gleaned from a reduction in benefits administration costs, and the fiendishly complex state second pension could be terminated.

It would also pave the way to reforming public sector pensions. With a state pension set well above the poverty threshold, the unions’ (legitimate) concerns over pension poverty would be addressed. The government would then be in a much stronger position to negotiate the public sector’s transition to a pure defined contribution (DC) pension framework. All of the state’s (that is, taxpayers’) limited capacity to absorb pensions-derived longevity risk would then be concentrated into a much-improved state pension, shared equally among all retirees, irrespective of their former sector of employment.

This feels fairer than Lord Hutton’s recommendations, because it would address the injustice of the 80% of workers who are in the private sector having to assume, and pay for, the longevity risk of the 20% in the public sector. In the meantime, the 80% are not able, themselves, to enjoy certainty of income in retirement until they die, with private sector occupational pension provision having become almost a defined benefit (DB) desert. Ending tax relief and redeploying the saving, as described, would make real the Chancellor’s claim that we are all in this together. And if that is a euphemism for a flatter society, then I am all for it.

Jeremy Mindell, senior reward and tax manager at Henderson Global Investors:

This is yet another proposal that looks good on paper but would be disastrous to implement. Like many other ‘good ideas’ – poll tax, abolition of the 10p tax rate, tower blocks, bendy buses – it fails to stand up to the cold light of reality.

Let us look at the origins of tax relief for pensions. The general principle in taxation is that you are taxed on what you receive. The basic principle of pensions is that you give up something now for a benefit later on. Clearly, if you give up income now, you have less means to pay tax and therefore tax is deferred until you get that income – simple, really. Don’t forget that 75% of your pension is taxed when you receive it as income. If it has grown while sitting in the pension scheme, the tax take is that much more.

Any attempt to tax pension contributions, such as on defined benefit plans, has the effect of taxing people on income they have not received and needs to be financed from other income. Hardly an incentive to save.
The other basis for tax relief on pensions is the desire to reward people who make provision for their future welfare, thus relieving the state of future burdens. This is an admirable principle that dates back to the introduction of income tax and gave the UK the best-funded pension schemes in the western world until the Gordon Brown pension tax raid.

The final perspective is that of cui bono and cui malus – who benefits and who suffers from these proposals? The people who would benefit fall into two categories – those who make no provision for their pension, and those who have already retired and would benefit from the higher state pension. These are the baby boomers who have benefited from free university education, relatively cheap housing and final salary pensions.

The people who would suffer are the younger generations in defined contribution (DC) pensions, who, because of declining investment returns and increased longevity, are facing an ever-greater challenge to achieve a higher pension. It is right and proper that people aspiring to be financially independent in their retirement should be given every encouragement.

Finally, the idiocy of this proposal is illustrated by, ironically, the most anomalous part of the pensions system – the tax-free lump sum. How do you to explain to a 64-year-old who has been saving for his/her pension for 45 years that, suddenly, s/he will lose a substantial incentive s/he has been saving for since 1966? Abolishing this anomaly would ruin any confidence there is left in the security of the registered pension scheme regime.

Perhaps the policy wonks who dream up these proposals should be put in a focus group with those who would feel cheated by these plans.

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