Pension pots needs to be topic to inheritance tax and new limits imposed on tax-free lump sum withdrawals to “even out” tax assist for retirement saving, an influential think-tank has stated.
Workers and employers obtain tax breaks on revenue tax and Nationwide Insurance coverage respectively, as effectively on inheritance tax, to create incentives to contribute to retirement schemes. About £115bn a 12 months is saved into workplace pensions within the UK.
However the Institute for Fiscal Research believes extra might be finished to assist many individuals dealing with low revenue in retirement, “who most want it.”
“The present system of pensions tax gives overly beneficiant tax breaks to these with the largest pensions, these with excessive retirement incomes and people receiving massive employer pension contributions,” stated the IFS.
In a report revealed on Monday, the IFS set out a variety of coverage measures to “even out” tax assist for pension saving reminiscent of “decreasing subsidies the place they’re overly beneficiant and rising them the place saving incentives are weaker”.
One of many key proposals is to make the 25 per cent pension tax-free lump much less beneficiant. Over-55s can withdraw 1 / 4 of their pension pot with out paying revenue tax on the cash.
“Whereas common, this gives a big tax subsidy to these with excessive incomes and massive pensions however is of no worth in any respect to these with the bottom incomes in retirement: non-taxpayers,” the IFS stated.
“At a minimal, the tax-free element needs to be capped in order that it solely applies to 25 per cent of, say, the primary £400,000 of accrued pension wealth: this could nonetheless depart about 4 in 5 of these approaching retirement unaffected,” it added.
Jason Hollands, managing director at Evelyn Companions, the wealth supervisor, stated a raid on the tax-free lump sum could be “significantly unwelcome”, particularly for many who might have deliberate to make use of it to assist repay a mortgage.
“Have been such a coverage to be carried out comparatively shortly, it may depart individuals in a really troublesome place,” stated Hollands.
The IFS additionally believes reforms are wanted to cease pensions being employed as an “easy-to-use car for avoiding inheritance tax” and desires revenue tax charged on inherited pension funds.
Andrew Tully, technical director with Canada Life, a pension supplier, stated together with pensions inside the IHT setting could be “massively unpopular” at a time when IHT is already hitting many extra individuals.
“It additionally dangers altering behaviour and never producing a lot in the best way of tax as wealthier individuals ‘rearrange the deck chairs’ by eradicating cash from the pension setting and shelter it from IHT in different methods, reminiscent of below belief,” he added.
The IFS proposed that staff get reduction from nationwide insurance coverage contributions on their pension contributions, in addition to revenue tax reduction. Nonetheless, in return, it stated pensioners ought to pay NICs on their non-public pension revenue — a transfer that might have an effect on higher-rate taxpayers having fun with bigger employer pension contributions.
“Whereas the idea of charging NI on pension revenue may be sound, it’s arduous to think about a state of affairs, within the quick time period a minimum of, the place a authorities feels it might go down this street with out sparking fury amongst older voters,” stated Tom Selby, head of retirement coverage at AJ Bell.
The IFS believes these reforms will allow the Treasury to be “extra relaxed” about rising the bounds on each the annual and lifelong allowances, each of which have been topic to a collection of cuts over the previous decade. The coverage of tapering the annual allowance for the very highest earners also needs to finish, it stated.
Sir Steve Webb, a former pensions minister, stated there was “little question” the present pension tax system was “advanced, generally arbitrary and has suffered from piecemeal reforms over a decade or extra”.
However he warned towards reforms that might quantity to retrospective taxation as savers immediately discovered “their cautious monetary plans now not added up due to a last-minute change to guidelines round revenue tax and NICs”.
“While ‘fiscal purity’ is admirable, a protracted listing of advanced reforms carried out over a interval of a long time will not be what pension savers want proper now,” stated Webb, a companion at pension consultants LCP.