Rich pensioners are getting the biggest tax breaks in a system that does little for those in lower incomes, according to a think tank.
The Institute for Fiscal Studies (IFS) said that the usual government route of reducing limits on pension saving “is not a good solution” and is calling for an overhaul of current system of pensions tax.
The think tank has set out a plan which reduces subsidies where they are “overly generous” and increasing them where saving incentives are weaker.
“Pension saving is treated generously for high earners. Even under pension caps, over £250,000 can be withdrawn from a pension free of income tax. Employer pension contributions escape National Insurance contributions entirely,” Isaac Delestre, a research economist at IFS, said.
“And pensions are an easy-to-use vehicle for avoiding inheritance tax. At the same time, the 25% tax-free component is worthless to those who do not pay income tax in retirement. And those making individual pension contributions receive much smaller subsidies,” he added.
In its report, A blueprint for a better tax treatment of pensions, the IFS proposes:
- Reform the 25% tax-free component to provide a more equal subsidy to all private pensions, benefiting those with a low retirement income.
- Give up-front employee NICs relief on all pension contributions, and tax pension income instead.
- Decouple the up-front tax subsidy from employer NICs.
- Reform the lifetime allowance and end the tapering of the annual allowance.
“Our proposals would boost the retirement incomes of low and middle earners and provide greater encouragement for them to save more in a pension. They provide a coherent vision for the taxation of pensions and don’t require the complexity, and big losses for some current basic-rate taxpayers, that would result from restricting income tax relief to the basic rate, for which some have argued,” Delestre said.
“Our system of pensions taxation has too many features that are arbitrary, wasteful or unfair. It’s long past time we retired them,” he added.
However, DIY investment platform Interactive Investor said that the favourable tax treatment available in pensions needs to be preserved and protected if a nation of pension savers is to be encouraged.
Alice Guy, personal finance editor at Interactive Investor, says: “Capping the tax-free amount you can withdraw from your pension would be a serious disincentive to pension savers. The 25% tax free pension incentive is one of the best well known and best-loved pension rules. Encouraging people to save more for retirement is a battle for hearts and minds and slashing one of the most popular pension benefits could have a chilling effect on pension saving.”
