These certainly added new ideas to the debate, including a complete overhaul of the interaction with national insurance contributions, controversial proposals to limit the much-loved tax-free cash entitlement and less generous tax treatment of employer contributions.
But major reforms of the pension tax system are fraught with challenges.
We’re (thankfully) not starting with a blank sheet of paper; millions of individuals across the UK have already built up private or workplace pension provision, defined benefit and DC, and in some cases very substantial sums are involved.
To me, one of the sacrosanct principles behind any radical reform would be to avoid retrospective adverse change. People who have been ‘doing the right thing’ shouldn’t suddenly find the rules have changed before they benefit from the proceeds.
One IFS proposal is to grant national insurance relief on personal contributions with national insurance then deducted from the proceeds. But surely, those who have not benefitted from national insurance relief on 40 years of contributions couldn’t be asked to pay this on future proceeds?
At the very least, we’d need a very lengthy transition, which creates layers of complexity.
There have been previous proposals to tax pensions like Isas. Rather than the ‘exempt, exempt, taxed’ (EET) approach, why not like Isas allow all proceeds tax free, but cancel tax relief upfront?
I see major downsides here because people value reliefs up front. Furthermore, the core aim of pensions is to provide an income throughout later life, but moving from EET and allowing all proceeds to be taken tax free immediately would not encourage the right behaviours.
An Isa style approach also couldn’t be incorporated into existing pensions – you’d need to ringfence every existing pension and set up a new one for every individual. The consequences for DB are horrific.
Even moving to a flat rate of tax relief creates major challenges. These are particularly high for DB schemes where a means would have to be found to convert additional entitlements into a contribution rate, then split employer/employee.
Salary sacrifice arrangements create further complexities and there could be a need to tax higher earners on employer contributions using some form of ‘benefit in kind’ approach.
Some would argue that the tax treatment of pensions on death is too generous, particularly in drawdown. But before rushing to impose inheritance tax on unused funds, the behavioural response this would prompt needs to be thought through.
Do we really want people to deplete their funds too soon, potentially falling back on the state?
And it’s on that behavioural note that I’ll finish. Pensions tax relief, while costly, is hugely beneficial. If there is an appetite for radical reform, the technical details need to be thought through very, very carefully.
