An influential think-tank has said the pension pot should be subject to inheritance tax and new limits should be placed on tax-free lump sum withdrawals for retirement savings.
Employees and employers get tax breaks on income tax and National Insurance respectively, as well as on inheritance tax, to create an incentive to contribute to retirement plans. In the UK, around £115 billion is saved in workplace pensions every year.
But the Institute for Fiscal Studies believes more can be done to support the many people facing low incomes in retirement, “who need it most.”
“The current system of pension tax provides overly generous tax breaks to those with the largest pensions, those with high retirement incomes and those receiving large employer pension contributions,” the IFS said.
In a report published on Monday, the IFS set out a series of policy measures to “sum out” tax support for pension savings, such as “reducing subsidies and increasing where savings incentives are weak”.
One of the key proposals is to make the 25 per cent pension tax free lumpsum less generous. People over 55 can withdraw up to a quarter of their pension pot without paying income tax on the money.
“While popular, it provides large tax subsidies to those with high incomes and large pensions, but has little to no value to those on the lowest incomes in retirement,” the IFS said.
“At a minimum, the tax-free component should be capped so that it only applies to 25 per cent of, say, the first £400,000 of accumulated pension wealth: this would still leave one in four of those approaching retirement unaffected, it added.
Jason Hollands, managing director of wealth manager, Evelyn Partners, said a raid on the tax-free lump sum would be “particularly unwelcome”, especially for those who may have planned to use it to help pay off a mortgage .
“Had this kind of policy been implemented relatively quickly, it could have left people in a very difficult place,” Hollands said.
The IFS also believes that reforms are needed to prevent pensions from being employed as “an easy-to-use vehicle to avoid inheritance tax” and wants to impose an income tax on inherited pension funds.
Andrew Tully, technical director of Canada Life, a pension provider, said that including pensions within the IHT environment would be “extremely unpopular” at a time when IHT is already killing many more people.
“It also runs the risk of changing behavior and not generating much in the way of tax as wealthy people ‘rearrange the deck chairs’ by taking money out of the pension environment and sheltering it from IHT in other ways, such as under trust.”
The IFS proposed that employees get relief from National Insurance contributions on their pension contributions, as well as income tax relief. However, in return, it said pensioners should make payments to the NIC on their personal pension income – a move which would have an impact on higher-rate taxpayers who enjoy large employer pension contributions.
Tom Selby said, “While charging NI on pension income may be good in principle, it is hard to imagine a situation, at least in the short term, where the government feels it can go down this path without angering older voters.” May go.” , head of retirement policy at AJ Bell.
The IFS believes these reforms will enable the Treasury to be “more relaxed” about raising the limits of both annual and lifetime allowances, both of which have been subject to a series of cuts over the past decade. It added that the policy of reducing the annual allowance for the highest earners should also end.
Sir Steve Webb, a former pensions minister, said there was no doubt that the current pension tax system was “complex, sometimes arbitrary and plagued by piecemeal reforms over a decade or more”.
But he warned against reforms that could amount to retrospective taxation as savers suddenly find “their careful financial plans undone by last-minute changes in income tax and NIC rules”.
“While ‘fiscal purity’ is commendable, a long list of complex reforms implemented over a period of decades is not what pension savers need,” said Webb, a partner at Pension Consultants LCP.