Incentivising savings – or reducing tax reliefs?

The chancellor has given Treasury officials more time to review the numerous responses received to the consultation; they now have until next year’s Budget statement to digest them.

Coming out of the blue, the consultation followed hard on the heels of the general election and the document itself looked like it had been prepared in somewhat of a hurry, lacking any real direction.

The only reference to the concept of a pension Isa appears not in the consultation document but in the chancellor’s Budget speech.

A three-way race

Reading between the lines, the consultation has little to do with its title but rather is aimed squarely at exploring ways to reduce the level of tax relief provided to those saving towards their retirement.

Even the document’s quoted figures are contentious. 

There is a conspiracy theory that the chancellor always thought the existing system would be retained but he would need to make further cuts

Despite this lack of direction, it soon became apparent that the Treasury considered the consultation to be a three-way contest between competing systems.

In hypothetical lane one is the Isa-style savings account, taxed on income on the way in, exempt while interest is accrued and exempt on withdrawal – a radical approach with an added incentive to encourage people to lock away money for many years on which they have paid income tax.

In lane two is a fixed-rate tax relief system of exempt income in, exempt interest accrued, taxed on withdrawal, with the strapline, ‘You save two and the government pays one’.

Bringing up the rear is the idea that we retain the existing EET system that has been in place for decades, but probably with yet more tweaks to reduce the tax burden to the exchequer.

Pension Isa’s popularity looks unstable

The pension Isa proposal, which looked to be favoured by the chancellor, got off to a flying start with much positive media comment and vocal support from a number of economists and fund managers. 

However, as the consultation developed, the attractions of the pension Isa system started to wane.

Questions were asked about how to deal with those – such as civil servants – who still enjoy generous defined benefit pension schemes. 

Recent press reports now suggest a pension Isa system is no longer the favourite and its odds are lengthening. 

A system of fixed-rate relief was known to be supported by the former pensions minister Steve Webb and still has supporters within the Department for Work and Pensions.

Fixed rate is also favoured by the contract-based providers that already operate tax relief at source for their pension plans and could easily adapt their systems to recover higher amounts of tax from the exchequer.

There are, however, disadvantages with the fixed-rate system – not least that many employers operate the alternative net pay tax relief through payroll and would have to change their systems. 

Fixed rate does not fit well with DB arrangements and it is not clear whether the relief would also apply to employer contributions. 

Retaining the existing system has the obvious attraction of familiarity, and avoids the need for employers and providers to adopt new systems. 

Indeed, there is a conspiracy theory circulating that the chancellor, as a consummate politician, always thought that the existing system would be retained but he would need to make further cuts to achieve the necessary tax savings.

If we end up with lower caps on tax-free lump sums or age-related lifetime allowance factors for DB schemes, we might breathe a sigh of relief and congratulate ourselves for averting more chaos. 

This is definitely not the reaction we would have seen had those changes been announced straight away in the Budget. 

Duncan Buchanan is president of the Society of Pension Professionals