Pensions tax relief
There’s been a lively debate over at Liberal Conspiracy on my post on public sector pensions. Many of the points are from the small-state right and entirely predictable and have been effectively rebutted already, but there have also been some others that deserve a fuller response than one can put in a comments thread.
First many people question whether the state is really spending money on pension tax relief, and some ask how it works.
Tax relief works by reducing what the taxman sees as income by the amount that you put into a pension.
If you don’t pay income tax it costs you one pound to put an extra pound into your pension. If you pay basic rate tax it costs you 78p. This is because basic rate tax is 22 per cent – if your taxable pay is reduced by one pound you will pay 22p less tax.
If you are a higher rate tax payer it costs 60p to put a pound in your pension, because higher rate tax is 40 per cent. That’s why it’s legitimate to talk about spending money on tax relief. Other tax payers are effectively contributing that 40p.
Pensions are a uniquely privileged kind of savings in their tax treatment. If you put money in a bank savings account, you do not get any relief and still pay tax on the interest. There is tax relief on savings in ISAs but they are limited – going up to £10,900 a year next year. Currently there is no limit on the tax relief on pensions savings made in a year (though you can’t build up your pension pot indefinitely).
The rationale for providing tax relief is that it is in the state’s interest for people to build up a pension so that there is less pensioner poverty and people do not require means-tested benefits. But the way it works at the moment means that the well-off don’t just get more relief because they earn more, but also because they get relief at the higher tax rate.
Let’s look at one particular post from Mac 3, as it represents much pensions world orthodoxy. I’m sure he won’t mind me reposting it here and commenting on each point he makes. He’s welcome to come back in the comments of course.
Mac 3> It has been a longstanding principle of UK pensions planning for years that pensions are regarded as deferred pay. As the eventual pension will be taxed as income on receipt, it has always been considered perfectly fair to grant full tax relief on an individual’s contributions to pension schemes. If – as the TUC seem to be proposing – pension contributions have to be paid out of taxed income (e.g. at 40% or 50%), and then some years later the pension derived from such contributions is taxed at say, 40% or even 50%, then the individual has effectively been taxed twice-over on the same monies!
NS> We are not opposed to the principle of tax relief on pensions. The question is at what rate the relief should be and how far up the income scale it should go. If you look at the HMRC tables we used for our work (which we based on Pensions Policy Institute methodology) they show that the cost of tax relief is £36 billion, while the income from taxing pensions is around £10 billion. If they were more in balance Mac 3’s argument would have a point.
Mac 3 >So Mark M is quite correct in challenging the irresponsible claim that high earners, by enjoying full tax relief on their contributions, are somehow being subsidised. They are not. They are simply deferring their liability to income tax until they come to pick up their pension in retirement.
NS> But they are also juggling their tax rates, and of course the super-rich are in the forefront of those demanding that they should not have to turn their pensions savings into annuities so that they can leave it to their dependents and thus not pay any kind of income tax on it.
Mac 3 >Do not forget that the proposed measures that arose out of the 2009 Finance Act aim not only to restrict tax relief on a high earner’s personal contributions to a pension scheme, but to impose hefty Benefit in Kind tax charges on the value of the employer’s contributions as well.
NS> And quite right too. This is one area of tax fairness where the government has made some welcome moves. If you look at the TUC’s PensionsWatch report into top pensions, it is clear that top directors are frequently not in the same scheme as their staff and negotiate their pension contributions as part of a tax planning/avoidance scheme. (I wonder if the Longbridge report looks at the pension arrangements of the directors.)
Mac 3 >It is highly disingenuous for the TUC, in its next breath, to lament the decline of private sector pension schemes. Just what does it imagine will happen when the senior directors of good occupational pension schemes no longer find it tax-effective for themselves to remain in those schemes? If the senior directors opt out (and frankly who could blame them) of such schemes, then there will be even less incentive for the sponsoring employers to keep such schemes going.
NS> But this has not worked. Generous tax relief has not stopped huge numbers of employers closing DB pension schemes, while keeping very generous pensions schemes in the boardroom. Spending £10 billion on an ineffective bribe strikes me as rotten politics. And hard as it is for some in the pensions world to accept the best defence of good DB schemes is effective union organisation.
Mac 3 >Unfortunately, this type of bash the rich mentality will only hasten the decline of good private sector schemes.
It is inevitable that any call for great fairness gets dubbed the politics of envy. Let me turn this round against all the public sector scheme bashers (which to be fair Mac 3 doesn’t mention in his post).
Unfortunately, this type of bash the public sector mentality will only hasten the decline of good private sector schemes.