IT’s hard to know what is most bizarre: the fact that the coalition and Labour are ganging up to vandalise the UK’s pension system, or that so few people have noticed or care. The disaster is on a similar scale to Gordon Brown’s infamous and at the time largely overlooked tax raid on pension funds in his first Budget.
The main issue today is this: the coalition is relentlessly cutting the amount of money that can be put into pensions every year (falling to £40k from 6 April) and the total amount that can be kept in it (falling to £1.25m). This may still sound very generous but in fact means that many more people will stop saving in these vehicles: imagine that you already have a few hundred thousand pounds in your pension, as many City workers and other professionals do, and you hope to earn a decent investment return over the next few decades. Seen in that light, it may well be that – when inflation is included – you already have enough put aside to reach the limit by the time you retire. And given that the maximum pot size is likely to fall again sooner rather than later, that may be a sensible calculation for many people to make.
Meanwhile, Labour is going to slash the tax relief top rate taxpayers get from 45p to 20p (the same as that received by basic rate taxpayers), dramatically reducing their incentive to stash cash into pensions. In theory, 40p taxpayers will retain their tax break (relief at 40p) but by then the system will look ever more ridiculous. They too will eventually be clobbered, especially given that record numbers of folk are being dragged into that tax band and thus able to claim the relief.
There is only one reason why people put money into pensions, and that is tax relief – the fact that you don’t pay income tax on the cash you put in a pension; in effect, you get to keep your pre-tax, gross income.
Without that, the current system makes no sense. There’s also a sensible rationale for this apparent tax advantage: income should only be taxed once. At present, it is not taxed when it goes in – but taxed normally when it comes out as an annuity.
This neat arithmetic is messed up somewhat by the fact that tax rates will vary, and also by the fact that people are now allowed to take a lump sum out tax-free – but the basic principle still holds. That is why raiding tax relief isn’t a free lunch, or why the current arrangements do not self-evidently equate to a subsidy, as some have claimed. There is an argument for doing away with tax relief altogether, of course, as part of comprehensive tax reform, but not for the purposes of raising money by stealth.
The reality is that trashing tax relief will kill off pensions as we know them. Why lock away your savings, often for many decades, without the ability to access them, in the absence of some sort of major advantage? Sure, you also enjoy other tax breaks but these are no different from what you get with Isas. Ultimately, the loss of liquidity, and the fact that the cash cannot be used to pay for a house or any other expense, is a crippling drawback. Many people will stop putting away significant sums of money in long-term pension vehicles (as opposed to short-term savings vehicles).
The only hope, therefore, is that auto-enrolment into pension schemes via the workplace – which is voluntary and has cross-party support – continues to work as the programme is extended, and that the vast majority of the public signs up. But even if this does happen, the system’s scope will have to be at least doubled and perhaps made compulsory; eventually, everybody will need to save at least 15 per cent of everything they earn throughout their lives. Britain needs to move to an Australian-style mass retirement savings culture. The current system is being killed off by our politicians; astonishingly, however, there is actually a chance that a better one could emerge from its ashes.