The Pensions & Lifetime Savings Association (PLSA) has warned that major reforms to the UK’s pension taxation system can see employers and pension funds take on substantial costs.
Over the last year, there has been speculation that the government plans to reduce the level of fiscal support for pension saving with changes ranging from removing higher rate income tax relief, reducing the annual or lifetime allowance, introducing a flat rate of tax relief for all savers of 25% or 30%, or overhauling the system so that all pension contributions are taxed at a person’s full marginal income tax rate upfront – known as TEE.
In a report published yesterday, the PLSA set out five principles on which any reform of pension taxation should be based.
- Promotes adequacy: provides financial support and incentivises saving for retirement;
- Encourages the right behaviours: helps savers make the right decisions about retirement saving;
- Fair: helps everyone – the employed, the self-employed, and non-workers – save for retirement;
- Simple to adopt and administer: avoids unreasonable transition and on-going costs for employers and schemes;
- Enduring and sustainable: designed to avoid repeated change and so builds confidence in long-term saving.
Tested against these principles, none of the main options for reform or indeed the current system of pension taxation achieve all the principles, the PLSA said.
Furthermore, a move to a single rate would have very substantial implications for the administration of occupational pensions resulting in much higher costs for employers and schemes, likely in total to amount to millions of pounds, the association warned.
“A reform of this magnitude would take at least two or three years to implement. Some experts believe it would result in the end of defined benefit provision in the private sector,” it said.
The PLSA’s Five Principles for Pension Taxation report includes PLSA analysis of Pensions Policy Institute modelling to illustrate the impact of different reform options on a range of individuals with different earning and tax profiles and who are members of different types of pension schemes.
While some of the reforms can result in higher private pension income for some groups of savers, even under the most generous scenario – one where government would adopt a single rate and give a 30% rate of relief – the biggest improvement any saver in a defined contribution pension scheme would see to their income replacement rate in retirement is only 1-2%.
This suggests that even major reforms might make relatively little difference to retirement income, the PLSA said.
Nigel Peaple, director of policy and advocacy at the PLSA, said: “We recognise that the UK is facing a very severe economic and fiscal environment as a result of the pandemic; but any potential reforms should be fully thought-through and assessed. The Five Principles for Pension Taxation can help government make the right decisions.”
He said admitted that “no single reform or the current system is perfect”, however introducing major change to the system of fiscal support for pensions “risks undermining hard-won confidence in pensions”.