Claire Trott: “While outside pension tax breaks seem pretty straightforward and lowering the rates a person could reclaim could be a quick win, there are several other ramifications to consider.”
Claire Trott is investigating the ramifications of introducing a flat-rate pension tax break, and while she says it would benefit low-income earners, this would not be a “quick fix” which many think it …
Pension tax breaks are so often viewed as an easy way for the government to save money, and over the past year the issue has been raised several times with such high spending. The latest report by the Finance Committee in early March again called for not just a review, but urgent reform.
It says: “In view of the regressive nature of the benefits that flow to individuals from the current regulation on preferential pensions, particularly in the top decile of earnings, the Chancellor should urgently reform the entire concept of preferential pensions.”
On the subject of matching items
The government has pushed this back and discarded the need for a full review, just as it did when the Public Finance Committee referred to pension tax relief in its mid-2020 report. The government also commented that the lifetime allowance has been frozen, effectively limiting not only tax-exempt saving but also the amount of tax-free money available to savers. He also pointed to other actions and previous reviews, including the 2015 major review.
On the face of it, a blanket tax break is very attractive and would certainly benefit many low-income earners, which would be positive. However, I think it’s fair to say that while outside pension tax breaks seem pretty straightforward, and lowering the rates a person could reclaim could be a quick win, there are several other knock-on effects to consider.
Loss of wages would not work if a flat rate relief were introduced or a higher tax relief abolished because a taxpayer with a higher tax rate would still receive full tax relief if he sacrificed his salary for employer contributions to retirement plans.
The taxable salary would be reduced so that they would no longer pay their highest marginal tax rate on that amount. The only way to get around this is to tax the member’s contribution, possible via the benefits in kind scheme, where a P11d is issued at the end of the tax year. This takes into account all benefits that the employee has received and the value of which should be taxed.
Other options would be available and are now being offered by employers, such as B. including the contribution or benefit in kind as a notional payment on a pay slip so that the correct tax is paid at that point, but this depends on whether the employer can offer this. This essentially negates the benefit of waiving a salary, at least with regard to tax relief.
So even though loss of wages for pensions has always been protected when changes are made, this could force the government to ban it for pensions as well.
Employers who have put in place new pension schemes to meet their automatic enrollment obligations have also seen significant pay cuts. It would be costly for the employer to stop offering the victim scheme and also to cut employee benefits, which the government is really not trying to do here – at least not for property taxpayers. The implication for the government is the added benefit of increased social security payments.
The same argument applies to employer contributions, if a flat rate or the abolition of a higher rate should be considered. Employer contributions to pension insurance are actually just another payment to the employee, although they flow directly into the pension. The employee receives the full marginal tax rate on this payment as it is not a taxed service. Employers could amend contracts for employees to give them a higher pension contribution and lower salary. This is not a loss of salary because the employee would never have been entitled to payment as salary, but the result is the same. Taxpayers with higher tax rates would benefit from higher tax relief even if the regulation only provided for personal contributions at a lower flat rate.
This, in turn, would mean monitoring employer contributions and taxing the employee accordingly to ensure that no one receives a different tax rate on their pension.
Final salary schedules
Final salary systems face challenges of their own, many are underfunded, and this can result in fewer funds flowing into the system from members depending on the distribution of the taxpayers who are members. This means that the employer may have to make up the difference in order to keep the system solvent.
The employer’s contributions are not calculated on the basis of the needs of the system, which means that the contributions are not attributable to the individual members in the same way as the contributions to the pension insurance through money purchase. This would mean that trying to ensure that taxpayers with higher tax rates do not get more than their fair share is impossible. Final salary regulations would therefore have to be exempted from these rules or another test applied. We already have significant differences in the treatment of cash-in and salary systems, and this would only make that worse.
Reviewing tax breaks and who will benefit from them is an important issue, but not the quick fix that many see in it.
I’ve always said that any change in this area requires extensive advice and careful consideration in order to get the right result. We want to make sure the tax breaks lead to the right behaviors that definitely require some intelligence to get right.
Claire Trott is Head of Pensions Strategy at St. James’s Place Group