THE pensions revolution could become a “pensions implosion” if the government moves ahead with radical changes to tax relief, the Pensions and Lifetime Savings Association (PLSA) warned at its annual conference in Manchester last week.
In April, savers aged 55 and over were given the freedom to spend their pension pots as they liked, abolishing rules that used to force the majority of savers to use their pots to buy annuities, which paid them an income for life.
Within weeks of the new rules coming into effect, the chancellor revealed plans to launch a consultation into whether or not the current system of tax relief should be changed.
“Pensions could be taxed like Isas,” George Osborne said.
Ruston Smith, chairman of the PLSA, which changed its name from the National Association of Pension Funds last week, issued a bleak warning to delegates in Manchester. He said: “If the government gets its way on reforms to pensions tax relief, we could see the recent wave of change — the pensions revolution — becoming a pensions implosion.
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“Tax change could dig up and smash the foundations set to create a society of lifetime savers, putting pressure back on our ageing society.”
A Treasury consultation on overhauling the generous tax breaks on pensions to make the system fairer and more sustainable finished last month, and the government’s plans could be revealed in the autumn statement on November 25.
Experts widely predict that any changes could particularly penalise higher earners — those who pay the 40% or 45% rate of income tax.
Savers currently receive tax relief as they pay into a pension. When they come to withdraw money from it, they can take the first 25% tax-free, but other withdrawals are taxed at their highest income tax rate.
For example, higher-rate taxpayers receive 40% tax relief — in essence, free money from the government to encourage them to save — on pension contributions.
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Basic-rate taxpayers receive 20%, and those who earn more than £150,000 gain the most at 45%. The tax relief bill has ballooned from £17.6bn in 2001-02 to £34.3bn in 2013-14.
The PLSA, founded in 1923, said it was not in favour of introducing a pensions Isa (dubbed a “Pisa”, contributions would come out of taxed income, but withdrawals would be tax-free) or to changing to a flat rate of tax relief for everyone, regardless of earnings.
Steve Webb, the former pensions minister, said changing to an Isa model would be “a huge gamble, like throwing a grenade into the middle of the room”.
He added: “The world is heavily skewed to pensioners and so none of them paying income tax seems implausible. It would be very hard to implement this change, and very messy.”
The former Lib Dem MP supports the idea of a 33% rate of tax relief. “So the government pays in £1 for every £2 contributed. If we can lock onto a ratio like this that everyone understands, it’s much harder for future chancellors to make little changes to raise revenue.”
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He added that a move to a flat rate would mean the lifetime limit on pension pots — currently £1.25m, falling to £1m next April — could be scrapped, simplifying the whole system.
Despite the PLSA’s warnings, most corners of the pensions industry seem open to change. Fidelity Worldwide Investment is calling for a flat rate of 25%, which would be “a sustainable incentive”.
Redington, an investment consultancy to pension funds, put forward one of the more radical ideas to the Treasury, whereby contributions receive the same tax relief as present, but withdrawals are completely tax-free too. The catch is that the annual allowance — currently £40,000 — would fall to £5,000, so people would not be able to save as much into a pension each year.
Lesley Titcomb of The Pensions Regulator said: “I think the industry has dealt well with the new freedoms, but the tax-relief consultation could be a game-changer. And there are costs involved with changing the system.”