The Treasury has little appetite for major pensions tax reform, according to David Gauke, the new secretary of state for work and pensions. Judging by the comments he made in a speech at the ABI conference a few weeks ago, the wealthiest savers and investors can breathe a sigh of relief. However, I think they should take little comfort from his words. If anything, this government’s disinclination to pursue bold reform could actually make matters worse.
There are many reasons why the government might want to make wholesale structural reforms to pensions. The system is inefficient, splurging vast sums of tax relief on relatively small groups of people — members of final salary pension schemes and higher rate taxpayers — yet fails to give assistance to those most in need.
Tax relief may be very generous, but it is also a complicated concept to grasp. Most people do not understand how it works. But if you don’t understand, it fails to act as an incentive to save. Therefore, this powerful inducement — tens of billions of pounds of public money which should be used to reward and incentivise us all to save for retirement — favours the wealthy minority.
However, Mr Gauke’s promise not to meddle rings true. The last government looked hard at pension tax relief. It was the logical thing to do after introducing pension freedoms. However, it met with such strong opposition from Conservative backbenches that it backed down, choosing to introduce the Lifetime Isa instead. If the government couldn’t push through a controversial reform back then, it is even less likely to try as a minority government.
So why is this still relevant? Following the general election result, the government is about to loosen the austerity belt in a bid to win back some goodwill with voters. Increasing public sector pay seems a likely next step. But this will be costly.
I fear that the Treasury is sharpening up its salami-slicing machine as it prepares to cut back allowances and benefits on retirement savings for the wealthiest, while hoping that not too many people will get cross about it.
So where will the Treasury make cuts? Limiting pensions tax relief seems the obvious area to target. The lifetime allowance (LTA) for pensions saving has already been slashed from £1.8m to £1m. It could go lower, but that will affect increasing numbers of people. The last cut, from £1.25m down to £1m, is estimated to be saving the government around £500m a year — not exactly small change.
Similarly, the annual allowance has come down from £255,000 a year (which even I think was ridiculously high) to £50,000 then £40,000. I would not bet against it going lower. The same is true of the money purchase annual allowance which has been reduced from £10,000 to £4,000 already, but could in theory be cut to zero.
The ones that really interest me are the allowances on defined benefit (final salary) pension schemes. Currently, a final salary pension is measured against the LTA on a 20:1 basis. This means you can have a guaranteed retirement income of up to £50,000 a year, inflation linked and with a spouse’s pension thrown in and you would not breach the LTA.
This is far more generous than the money purchase pension system offers. Based on current annuity rates, a £1m fund in your defined contribution pot would only buy you a guaranteed income of around £28,000 a year.
So an easy win for the Treasury might be to change the multiplier on defined benefit pensions from 20:1 to 30:1. This would mean that individual with a £50,000 a year final salary pension would have a retirement fund worth a notional £1.5m. This would result in a tax charge of 55 per cent on £500,000 of the fund above the £1m LTA — an easy £275,000 windfall for the Treasury.
Multiply this out across the millions of beneficiaries of those generous final salary pensions, and pretty soon you are looking at raising serious money. It is also worth noting the intergenerational dimension to this policy. The vast majority of the significant final salary scheme beneficiaries are over the age of 45. Anyone getting a guaranteed income of £33,000 a year (as would be the limit on a 30:1 calculation) would still be getting a better guaranteed pension than the average worker’s income.
Ultimately, the government and the pensions industry have to find a way past continued salami slicing and come up with a fairer, simpler and more sustainable pension system which serves the needs of all pension savers. The government may not have the capacity to act decisively on this issue now — but it could launch a savings commission to generate some the cross-party support.
Tom McPhail is head of retirement policy at Hargreaves Lansdown