Should higher-rate tax relief on pensions be scrapped?
The coalition government has made significant pledges to try and address the pension savings gap. But what about the issue of higher-rate taxpayers receiving added tax relief on their pensions?
Scrapping 40% relief is one way of tackling the country's pension deficit, argues Dr Ros Altman, an independent policy adviser on pensions, while Nigel Peaple, director of policy at the National Association of Pension Funds, questions if this is fair on higher-rate taxpayers who pay more tax in their working life.
In the yes corner: Dr Ros Altman, economist and independent policy adviser on pensions
Higher-rate tax relief costs billions of pounds each year in lost tax revenue. Given our fiscal situation, many argue we can no longer afford to be so generous to higher earners.
Tax relief is supposed to be an incentive to encourage people to contribute to pensions, but
using the tax system to do this means we are giving higher incentives to those who need the least help.
Those in favour of keeping higher-rate relief argue that it simply allows pensions to only be taxed once.
However, there are so many leakages in our tax system that most people who receive top-rate tax relief, don't pay higher-rate tax on retirement.
Only around 2% of pensioners pay higher-rate tax, compared with around 12% of working-age people, and the tax-free lump sum means only 75% of a pension is taxable.
Top-rate tax relief is given to workers on their entire contributions, but higher-rate tax is only payable on the top slice of pension income above the tax-band threshold.
And now some people are taking advantage of QROPS (qualifying recognised overseas pension schemes), which mainly benefit ex-pats, allowing them to shelter their pension overseas and avoid UK tax in retirement.
I'd rather see tax revenue funding a decent state pension, which would take pensioners above the means-testing threshold, and I'd support removing top-rate tax relief if the money was used for a fairer state pension for all – and one that doesn't penalise private pension savings.
But, so far the plans haven't proposed this. The last government took away some of the tax benefits, but didn't redistribute the money to other people's pensions.
Basic-rate relief is still an incentive, just not as generous as top-rate relief. Perhaps we need to be considering whether we need a better system than tax-relief for encouraging long-term saving?
In the no corner: Nigel Peaple, director of policy at the National Association of Pension Funds (NAPF)
The NAPF is pleased the coalition agreement set out by the new Liberal-Conservative government makes no mention of removing higher-rate tax relief.
When the country needs less debt and more savings, the last thing any politician should be considering is tax changes that undermine long-term saving in pensions.
The NAPF is steadfastly opposed to any proposals that undermine the UK's established approach to the financial treatment of pension savings.
Pensions are tax-exempt while individuals are saving for them and as the investment pot grows – but they are subject to taxation when income is taken in retirement.
Without tax relief applying at the rate a person pays income tax, many savers risk having their pensions taxed twice – once when they contribute to their pension and again when the pension is paid.
This double-tax take would heavily penalise those who save for their retirement.
Removing higher-rate tax relief would not only hit the highest earners – more than three million people would be immediately affected.
People from all walks of life could receive higher-rate tax relief, from marketing managers and IT staff in the private sector to air traffic controllers and police officers in the public sector.
And we estimate that a similar number could be affected in the future. This is because incomes are not static and workers move in and out of the higher tax band. Over a lifetime, perhaps a quarter of the workforce can expect to receive higher-rate tax relief.
Workplace pension saving has declined over the past few decades, and the current economic environment is making it harder for employers to provide good pensions.
Cutting tax relief now would send the wrong signal to employers and employees and could encourage another wave of scheme closures or reduced savings.
What do you think about higher-rate tax relief on pensions? Have your say in our forum.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.