Pension pots ought to be topic to inheritance tax and new limits imposed on tax-free lump sum withdrawals to “even out” tax help for retirement saving, an influential think-tank has stated.
Workers and employers obtain tax breaks on earnings tax and Nationwide Insurance coverage, respectively, as nicely on inheritance tax, to create incentives to contribute to retirement schemes. About £115bn a 12 months is saved into workplace pensions within the UK.
However the Institute for Fiscal Research believes extra may very well be achieved to help many individuals going through low earnings in retirement, “who most want it”.
“The present system of pensions tax supplies overly beneficiant tax breaks to these with the largest pensions, these with excessive retirement incomes and people receiving massive employer pension contributions,” stated the IFS.
In a report printed on Monday, the IFS set out a variety of coverage measures to “even out” tax help for pension saving similar to “lowering subsidies the place they’re overly beneficiant and growing them the place saving incentives are weaker”.
One of many crucial proposals is to make the 25 per cent pension tax-free lump much less beneficiant. Over-55s can withdraw 1 / 4 of their pension pot with out paying earnings tax on the cash.
“Whereas standard, this supplies a big tax subsidy to these with excessive incomes and large pensions however is of no worth in any respect to these with the bottom incomes in retirement: non-taxpayers,” the IFS stated.
“At a minimal, the tax-free part ought to be capped in order that it solely applies to 25 per cent of, say, the primary £400,000 of collected pension wealth: this might nonetheless depart about 4 in 5 of these approaching retirement unaffected,” it added.
Jason Hollands, managing director at Evelyn Companions, the wealth supervisor, stated a raid on the tax-free lump sum could be “notably unwelcome”, particularly for individuals who might have deliberate to make use of it to assist repay a mortgage.
“Had been such a coverage to be applied comparatively shortly, it might depart folks in a really tough place.”
The IFS additionally believes reforms are wanted to cease pensions being employed as an “easy-to-use car for avoiding inheritance tax” and needs earnings tax charged on inherited pension funds.
Andrew Tully, technical director with Canada Life, a pension supplier, stated together with pensions throughout the IHT setting could be “vastly unpopular” when IHT is already hitting many extra folks.
“It additionally dangers altering behaviour and never producing a lot in the best way of tax as wealthier folks ‘rearrange the deck chairs’ by eradicating cash from the pension setting and shelter it from IHT in different methods, similar to below belief.”
The IFS proposed that staff get reduction from nationwide insurance coverage contributions on their pension contributions, in addition to earnings tax reduction. Nevertheless, in return, it stated pensioners ought to pay NICs on their personal pension earnings — a transfer that might have an effect on higher-rate taxpayers having fun with bigger employer pension contributions.
“Whereas the speculation of charging NI on pension earnings may be sound, it’s onerous to think about a scenario, within the quick time period at the least, the place a authorities feels it could actually go down this highway with out sparking fury amongst older voters,” stated Tom Selby, head of retirement coverage at AJ Bell.
The IFS believes these reforms will allow the Treasury to be “extra relaxed” about growing the bounds on each the annual and lifelong allowances, each of which have been topic to a collection of cuts over the previous decade. The coverage of tapering the annual allowance for the very highest earners must also finish, it stated.
Sir Steve Webb, a former pensions minister, stated there was “little question” the present pension tax system was “advanced, generally arbitrary and has suffered from piecemeal reforms over a decade or extra”.
However he warned towards reforms that might quantity to retrospective taxation as savers abruptly discovered “their cautious monetary plans now not added up due to a last-minute change to guidelines round earnings tax and NICs”.
“While ‘fiscal purity’ is admirable, an extended checklist of advanced reforms applied over a interval of a long time will not be what pension savers want proper now,” stated Webb, a accomplice at pension consultants LCP.