To continue my series on tax reforms, which could go on for a very long time (and I am open to suggestions as to desired reforms), this time the issue is an obvious one if the problem of growing, and tax subsidised, inequality in the UK is to be tackled.
Cap pension tax relief contributions at 20%
Tax reliefs for pensions cost in excess of £50 billion a year. It is unlikely that almost any new investment in UK business or other economic activity arises as a result. This cost is, then, simply a subsidy to saving, most of which is given to those who are already wealthy or high earners. Pension tax reliefs also create a perverse distortion. Since they are usually provided at a taxpayer's highest marginal income tax rate many higher rate taxpayers get twice as much tax relief for each pound that they pay into their pension as does a basic rate taxpayer. This double rate of subsidy serves to increase income and wealth inequality in the UK. The problem can very easily be solved: tax relief on pension contributions should only be available at the basic income tax rate in future.
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Surely one of the further inequities of the current system is when the pension is paid. That pension is usually much lower, at around on average 60 percent of their salary whilst working, but is taxed at a lower rate [usually the base rate of 20 per cent] than the marginal rate of tax relief they received on their contributions thus multiplying the subsidy still further.
Pensions is obviously a complicate area and i do believe individuals should be encouraged to save for their future at a time in life when they are maximising their earnings (as our ability to earn typically diminishes with age) and i do agree “this cost is, then, simply a subsidy to saving, most of which is given to those who are already wealthy or high earners” although i do not consider myself a particularly high earner and pension tax relief has encouraged me to save into my pension which is a good thing.
What does require more work and analysis is the cost to the taxpayer of state backed final salary schemes and the comparison with those who have to fund a pension..i am not sure the argument “it is compensation for as i could have learnt more in the private sector” argument carries in this low interest rate environment as the amount you need to fund personally to buy an annuity to match a state backed final salary pension is absolutely staggering..perhaps there should be more incentives given to those who have to save for there pensions but that these incentives do not favour the wealthy??
You are missing the point and substituting an alternative agenda
They are not the same issue excepting re tax relief on contributions, where my comment applies equally
The state backed schemes are not an issue here: you are adding a red herring unnecessarily for no gain
“The state backed schemes are not an issue here: you are adding a red herring unnecessarily for no gain”
Well i am questioning whether people saving into there own pension are treated fairly compares to state backed final salary schemes..i understand it was not your specific point but as i say it does require more work as as it stands there is a much bigger subsidy given to state pensions than the 20% tax relief on contributions for those in the private sector
You can ask that
But it’s not the issue here
The question about at what rate tax relief is given is not a question of being wealthy already and therefore the tax relief should be capped. It is more about equity across tax years between tax payers. To take an extreme example if 2 people earn £1m across their lives but person 1 earns evenly over that period Person 2 earns a £1m in one year and then nothing. Under this analysis Person 2 pays more tax on the same earnings as Person 1 on the same earnings. Pension tax relief therefore tries to smooth out these distortions over a number of years. Surely that is fair? It is especially the case now that pension pots form part of your estate and are taxed at 40%. Under your system people who earn high amounts pay far more than their share.
Pensions are about deferring tax not avoiding tax. To further increase the efficacy the tax free lump sum should be abolished as it is a giveaway.
If you have to make an argument in extremis to prove your point in a tax case it’s likely to be an inappropriate claim
It is here
If the tax relief was 20% then it would apply equally in both cases
And you’ll have to explain in detail your claim that those who earn high amounts pay more…and use real-world examples, not absurd ones
I can accept your point on the tax-free lump sum
I may make that a later recommendation
I would agree with Richard about the 20% tax relief limit. However I think there is a bigger issue about pensions. I think for most folk a much better policy would be a much higher state pension for all. It takes a bit of getting your head around but a pension is actually always paid out of the current resources of that society. Whether you have accumulated financial assets or not isn’t in reality very relevant. Whatever the pensioner gets in terms of goods and services in e.g. 2040 will come out of what is produced by those in employment in 2040. The only way that could be different would be if you stockpiled your savings in the form of tins and packets in the garage. So you might accumulate lots of financial assets (i.e. claims on societies resources), but in 2040 you will have to sell those to the younger generations in order to claim a cut of what they are producing. You could cut out all the finance sector sharks that feed on the pension industry by just doing what is in effect exactly the same thing via the State and its taxing and spending.
Tim
I have been arguing this:
Something I can never understand with pensions is that a ‘fund’ is required to finance it at the start of retirement. Yes, quite obviously, but as that individual moves towards there demise then the ultimate cost is zero at the end as no assets have to earn an income as the recipient is dead. So a combination of income and the depletion of capital is needed to fund it. Therefore it is nonsense to suggest that the capital required at the onset of retirement is necessary to fund it throughout its lifetime and needs to be carried forward throughout the life of retirement. In reality the sum required is somewhat less, although the pension ‘industry’ would persuade us otherwise, so off topic a bit but it is not, with respect, as it is used an unsustainability argument for public sector pensions.
There is no fund in the case of public sector pensions
Universities and local authorities apart
The suggestion is completely appropriate. Far to much tax relief given on pension contributions is little more than a subsidy to the already comfortably off.
To be fair however, tax payable on the pension payments coming out should also be capped at 20% to the extent that they are attributable to contributions on which tax relief was capped. I know this will result in complexities for pension funds that contain a mixture of capped and uncapped contributions but it should not be beyond the wit of the actuarial profession to find a workable solution.
To be even fairer, Class 1 NIC contributions should apply to employer contributions as if they were salary payments. And to be even more fair, the upper earnings limit for Class 1 primary and Class 4 NIC payments should be scrapped, but I accept this is getting off-topic.
Tell me what part of income you would deem to be the pension paid?
If the bottom part I have little difficulty with your suggestion
I will get to NIC
Good point – hadn’t thought of it. Yes, it should be the bottom part.
When you get to NIC, I expect investment income is in your sights but if it isn’t, please do think about at least including dividends from owner managed companies (i.e. wages by other means).
It is in my sight…soon…
I think you need to hammer home why the step change in NI contributions is part of the problem, and makes income taxation regressive at certain levels.
Once you earn 50k, your employees NI rate drops 10% but the PAYE rate jumps 20%. But you can defer the 20% jump by offloading the excess into a pension pot, and then withdrawing it later in life at 20% ( with a quarter of it being tax free ). Ergo, it’s regressive.
It helps to not need the income at the time of course.
The 20% cap should also apply to Gift Aid.
There could be some compensating tax break though, such as abolishing Stamp Duty Land Tax which acts as a brake on high earners moving around the country to where they create most value, and then vacating housing in areas with high earning potential when they are past their best, widowed, children all grown up, want to live nearer care services etc.
I will get to the NI and gift aid points
I can see this series running for some time….
I know you have already said you will come to NICs, but I just wanted to make a suggestion that you mention it specifically in relation to rental income vs earned income.
Noted….
I knew we would fall out eventually 🙂 I think we can safely predict that reducing the tax relief for pension contributions will inevitably lead to a reduction in pensions savings. Perhaps that is what you want. That said, you probably claw a lot of that back from automatic enrolment.
Are you going to require higher paid employees with final salary pensions to pay 20% or 25% tax (the difference between the 40% or 45% rate and the 20% relief) on the value of the increased pension rights each year (equivalent to the amount a person with a defined contribution pension would have to put into their pension pot to achieve a similar increase in pension rights)?
That is the sort of thing that stops doctors working to clear backlogs. Is that what we want?
For anyone interested in this area, I’d recommend viewing the video and slides from the IFS’s recent event on the future of income in retirement. https://www.ifs.org.uk/events/1684
I haven’t actually suggested capping contributions – I have suggested capping relief
I would be happier about more contributions with a lower rate of relief
I’m not too bothered about a cap on contributions – it only went away temporarily with pension reform when it was thought that the lifetime allowance would be sufficient.
But what are you going to do about higher and additional rate taxpayers in final salary pension schemes? Will they pay tax each year on the increase in value of their pension rights? If not, why not?
But they don’t as such have a fund
If they transferred it out they would
But I’d suggest few should be so unwise
Instead they have an entitlement to an income
I am really not sure what you are saying is taxable when the entitlement is
For once I do not follow your logic
Usually I do
I wouldn’t disagree with your proposal.
In addition, I would re-direct basic rate relief (where HMRC physically send to scheme administrators) away from the Investment houses/Insurance companies to local authorities to
earmark for the construction of good quality council houses.
This could be achieved in the form of Bonds where pension schemes would receive a yield of circa 4%.
My understanding from HMRC is that the amount would be in the region of £1.2bn a year.
It would also give a much needed boost to the construction and engineering sectors, plus many associated industries.
Sorry, but what is the basis for the £12bn estimate?
It’s based on actual amounts HMRC send to scheme administrators for basic rate income tax relief on personal contributions.
Separate from basic rate relief where the member obtains tax relief from company contributions on his/her behalf. i.e. not taxed on company contributions. S308 ITEPA.
OK, I get that
Interesting
I’d deal with this a different way….to come in due course
Sorry £12bn a year. The £1.2bn figure was from Scotland.