Tax relief on pensions is a scandal: this is how George Osborne could fix it-By Chris Noon

Comment: Public servants with final salary pensions are unfairly advantaged, while many workers are prevented from saving for the pension they need

George Osborne should scrap the lifetime limit on pension savings, says Chris Noon Photo: Julian Simmonds/The Telegraph

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The dust had barely settled on the great pension simplification of 2006 before successive governments started meddling with pension savings. The pace of meddling has accelerated, with the past five years seeing year-on-year changes to the amount of tax relief offered to pension savers.

The argument for the changes has moved on over this period. From “high earners are benefiting from a disproportionate amount of tax relief” to “we’re spending too much money on tax relief”. The latter argument was used by George Osborne in the pre-election Budget as he announced a further reduction in the maximum amount you can have in a pension to £1m from April 2016 (down from £1.8m just four years ago).

The increased cost of tax relief should have been no surprise to Mr Osborne – it’s predominantly a result of employers being required to automatically enrol their employees into pension plans since 2012. I hope that someone at the Treasury lets the Chancellor know that the cost of pensions tax relief from auto enrolment will rise again from 2017‑18 and even further in 2018‑19 as minimum contributions increase from the current 2pc of pay to 8pc.

Whatever arguments are made to justify the meddling, it’s clear that the Treasury sees the £30bn or more that’s spent on tax relief as a soft target for increasing short-term tax revenues without a care for the long-term implications for retirement incomes.

In many ways the Government is guilty of treating pension savers in exactly the same way as it has accused (and legislated against) the pensions industry abusing customers (over charges, mis-selling, etc). It is taking advantage of the generally poor understanding of pensions to put through substantial tax increases.

Where are we now?

The annual allowance (the maximum you can save tax-efficiently in a pension in any tax year) is £40,000.
For most of us, this means we can save a maximum of £40,000 a year in our “money purchase” or “defined contribution” pension plans. For those lucky enough to have a final salary pension, the deal is slightly better.
When the notional amount that you can save in a final salary pension each year is calculated each year from the pension entitlement you are building up, it is worth substantially more than £40,000.
The lifetime allowance (the maximum amount your pension can be worth and still qualify for tax breaks) will be £1m from April 2016.
For a money purchase pension plan, this equates to an index-linked pension of around £30,000 a year at today’s annuity prices. This is a significant sum but by no means in “fat cat” territory – the Department for Work & Pensions’ own targets suggest that anyone earning more than £70,000 a year should be aiming for this amount. But for a final salary pension plan the maximum is £50,000 a year, not £30,000.
Then there’s the question of curtailing tax relief if you earn more than £15,000.
In its desperate pre-election panic, the Conservatives decided to neutralise any new Labour policy by, essentially, adopting it. So we now have the threat of a sliding scale of annual allowance that tapers from £40,000 at £150,000 of earnings to just £10,000 for those who earn more than £210,000. This policy is remarkably similar to one that the last Labour government introduced before the 2010 election, which was ridiculed (and thrown out) by the Coalition government. We can only hope that with its newfound confidence, the Government does exactly the same with this rehashed policy.

So where should we be?

We need a framework for pension tax relief that’s sustainable and fair, encourages pension saving and, importantly, is wholly owned by a single government department – not split, as now, between the DWP and the Treasury. Difficult as it may be to imagine, what might the new regime look like?
1. Flat-rate tax relief: I’m a convert to flat-rate tax relief on pension saving – perhaps at the 33pc level suggested by Steve Webb, the former pensions minister). It’s a much more effective mechanism for the redistribution of tax relief than the current policy, and gives everyone an incentive to save.
2. The removal of the lifetime allowance: The move to flat-rate relief would impose a natural tax-efficient pension limit of the basic/higher-rate income tax threshold. Pension savings above this limit would result in high levels of income tax being paid by individuals (when both pre- and post-retirement income tax is taken into account). Removal of the lifetime allowance also fixes the scandalous inequity between money purchase and final salary pensions plans (which are mainly the preserve of the public sector, including MPs).
3. Overhaul of the annual allowance: We need earnings-linked increases to the annual allowance written into law, taking short-termism and politics out of the future treatment of the threshold. In addition, the treatment of final salary benefits needs to be brought into line with money purchase benefits.
These feel like pretty simple changes. Let’s hope Mr Osborne’s team read this article in advance of the July Budget.
Culled from Telegraph