Save it for another day: pension tax relief and options for reform

Published on Debt & Savings

The Treasury has reportedly backed away from pension tax reforms, at least temporarily. Given the scale of existing tax relief, its particular benefits for higher income savers, and the potential wider impact of any change, this is perhaps understandable. But there remains a strong case for making the current system cheaper, fairer and better targeted. It is an agenda that should be revisited.

  • There are many good reasons for wanting to consider approaches to reforming the current system of pension tax relief. The current model is expensive and highly regressive, yet too many people still enter retirement with inadequate incomes. To the extent that progress has been made in this area in recent years, it has largely been driven by the introduction of auto-enrolment. Existing financial incentives appear to be poorly tailored to the needs of lower income individuals in particular,
  • Both of the main options for reform that have been discussed in advance of the Budget – moving either to a single rate of tax relief or shifting towards a ‘TEE’ system with a capped matching contribution from government – have the potential to save the government money, make the system less regressive and better target incentives on those with the greatest need. Yet the reforms appear to be off the agenda. For now.
  • Given the range of unknowns associated with any move – and especially with the radical move towards ‘TEE’ favoured by the Chancellor – this outcome is perhaps unsurprising. But it appears that timing has played a key role in this decision too. In part this reflects the fact that the pensions industry is already dealing with significant change – in relation to auto-enrolment and the new pension ‘freedoms’ introduced from April 2015 for example.
  • But in part it is political too. Given the potential for the biggest losses under ‘TEE’ to be felt by those with middle and higher incomes, any reform along these lines would be likely to create some controversy within the government. With the European referendum already opening up debate within the Conservative party, the Chancellor appears to have decided to avoid opening up another potential point of contention.
  • Yet these timing issues might be expected to diminish over the coming years, raising the prospect of reform later in the parliament. Given the scale of the sums involved and the clear weaknesses in the current approach, further debate would be welcome. We are clear that any eventual reform should deal with the inequity that is inherent in the provision of tax relief and we believe there is scope to make fiscal savings along the way. But we are equally clear that reform would bring significant practical risks with it and must therefore be approached carefully. While the post-Summer Budget consultation has raised a range of issues for consideration, we hope that any future decision builds on a second, more detailed consultation – with the government setting out a very clear articulation of the approach it wishes to debate.