Pension tax relief - radical reform or daylight robbery?

25 February 2016
Steve Webb, our Director of Policy and External Communications, provides a summary of Royal London's latest policy paper.

With the Budget just weeks away, Royal London has published its own analysis of the options for reform of pension tax relief. Our latest policy paper, entitled 'Pension Tax Relief - Radical Reform or Daylight Robbery?', looks at the options open to the Chancellor.

Option 1: more tinkering

The first - and probably worst - option is yet more tinkering. The Chancellor can always find a few hundred million pounds by changing some limit in the tax relief system. But we believe that the system desperately needs simplicity and stability, not more tinkering and added complexity.

Option 2: pension ISAs

The second option is the idea floated in the July 2015 Budget of making saving for a pension more like saving for an ISA. Under this approach, you would no longer get up-front tax relief on contributions into a pension. Instead, contributions would be made out of after-tax income. But all growth in the pension fund and later withdrawals would then be tax-free.

Whilst we can see the attraction to the Chancellor of this approach, we have grave misgivings. Abolishing up-front tax relief on pensions would be hugely disruptive and it is not clear how employers in particular would respond. If the new system made them query the value of providing workplace pensions (beyond the legal minimum for automatic enrolment) then this could fatally undermine pension saving.

Running pension ISAs alongside the huge 'legacy' of existing pension accounts would also be hugely expensive. Each individual would have one or more 'not-yet-taxed' pension pot from the past and would need a separate 'already taxed' pension pot for the future. The cost and complexity of this does not bear thinking about.

A pensions ISA would move tax revenue from the next generation (when today's workers retire) to the present generation (when today's workers are saving). This is attractive to the current Chancellor but reduces the funds available in a generation when the cost of an ageing society will be more acute.

We view this as a form of 'theft' from the next generation.

Option 3: up-front relief

The final option is a flat-rate of up-front relief. We have no problem in principle with a generous rate of up-front relief (eg 33%) giving more help to lower earners whilst still making pension saving attractive for higher earners (who can still benefit from a tax-free lump sum).

But a much lower rate of relief, such as the 25% that has been mooted would seriously damage pension saving. The Chancellor should not be balancing his books by stealing money from those who are being prudent in saving for their old age.

About Royal London Policy Papers

The Royal London Policy Paper series was established in 2016 to provide commentary, analysis and thought leadership in areas relevant to Royal London Group and its customers.

Read all our policy papers at royallondon.com/policy-papers.

About the author

Steve Webb

Director of Policy and External Communications

Steve Webb is now Director of Policy and External Communications at Royal London. Before this he was Minister of State for Pensions between 2010 and 2015, the longest-serving holder of the post. During that time he implemented major reforms to the state pension system, oversaw the successful introduction of auto enrolment and played a key role in the new pension freedoms implemented in April 2015.

Last updated: 25 Feb 2016

This website is intended for financial advisers only and shouldn't be relied upon by any other person. If you are not an adviser please visit royallondon.com.

The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London EC3V 0RL.