The current system of pensions tax provides “overly generous” tax breaks to those with the biggest pensions, with high retirement incomes, and those receiving big employer pension contributions, a new report has warned. Meanwhile, it does “relatively little” to support many of the people who face low income in retirement – who need it the most.
Proposals from the Institute for Fiscal Studies (IFS) set out to reform the 25 percent tax-free component to private pensions to make the system more fair and benefit those on a low retirement income.
The group is also calling for upfront National Insurance (NI) contributions relief on all pension contributions with income from pensions to be taxed instead.
Analysts claim the current system, which allows a person to take a quarter of the pension without paying income tax, unfairly benefits the wealthy, while those on lower incomes receive little benefit.
The group has set out “at a minimum” replacing the tax-free component should be capped, for instance so the 25 percent applies to only the first £400,000 of accumulated pensions.
This would leave four in five of those approaching retirement unaffected while reducing the sizable tax relief for more wealthy Britons.
The institute said it would be better still to replace the tax-free element with a new subsidy, which would be as generous as the present system to basic-rate taxpayers.
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The new subsidy would provide more generous support to non-taxpayers with no support for those paying higher-rate income tax in retirement.
Another proposal from the group is to give upfront NI contributions relief on all pension contributions.
The group is calling for a move to a system where all private pension income is made is subject to employee NI contributions.
Transitioning to this system would benefit low and middle earners who make individual contributions, the group claims.
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Tom Selby, head of retirement policy at AJ Bell, said the tax reforms set out by the IFS were “well thought through”.
He said: “Some of the ideas put forward here, in particular capping pensions tax-free cash, would be deeply controversial and risk a backlash of biblical proportions from voters.
“Others, such as making the tax treatment of pensions on death less generous, are potentially more doable but still come with challenges.”
Commenting on the proposal to make pensioners pay National Insurance, Mr Selby said: “It is something of an anomaly of the UK tax system that pensioners do not pay National Insurance contributions.
“After all, older people are more likely to rely on public services like the NHS – so, theoretically at least, it would make sense for them to help fund those services by paying NI in the same way working people do.
“While the theory of charging NI on pension income might be sound, it is hard to imagine a situation, in the short-term at least, where a Government feels it can go down this road without sparking fury among older voters.”
