What might the Chancellor do on Budget day?
The Chancellor hatches a plan for a pension raid on older savers to fund tax breaks for the young: How might it work and would the backlash be too great?
Rumours are rife that Chancellor Philip Hammond plans to fund a Budget giveaway to young people by slashing pension tax breaks for older savers.
The Government is reportedly keen to woo young voters who are struggling financially - perhaps by cutting their tax bills, or finding ways to write off student debt, or launching new measures to help them onto the housing ladder.
To pay for this, a raid on pensions tax relief is said to be back on the table.
This popular incentive allows everyone to save for retirement out of untaxed income, but costs the Government an estimated £38billion a year in contributions to pension pots.
It is unclear how the Government might tinker with pension tax relief, and whether it would only target older savers or do so across the board to fund other priorities in the Budget on 22 November.
But pension experts have rushed out warnings that the Chancellor would create a financial hole in the retirement funds of many people, and face practical problems in changing the current regime.
We take a look at the options open to Hammond if he wants to take pension tax breaks away from older generations, and examine the potential pitfalls.
What might the Chancellor do on Budget day?
An overhaul of pensions tax relief has dangled over the heads of savers since the Tory Government considered but ultimately abandoned the idea ahead of the Brexit vote.
The threat of abolition or dramatic cuts appeared to have lifted under the current Work and Pensions Secretary David Gauke, who said in July he 'wouldn't expect to see any fundamental changes in the near future'.
But if, as rumoured, Hammond is taking another look in order to bankroll a big giveaway to young voters, what are the possible alternatives he might be mulling over?
Axe relief altogether
Former Chancellor George Osborne is said to have come very close to abolishing the pension tax relief incentive, where everyone gets an initial boost to their retirement fund from tax relief, in favour of everyone saving into Isas out of their taxed income.
This idea could be revived, but it would be a drastic move to free up cash for other policies helping younger voters - and their pensions would take a hit from it too.
Introduce a flat rate
The Government currently [pays tax relief on pension contributions at people's 20 per cent, 40 per cent or 45 per cent income tax rates. Pensioners then pay income tax on withdrawals in retirement.
To advocates of the system this makes perfect sense. The principle is that you save into a pension from tax-free income, therefore if you pay a higher tax rate you get a higher relief to make this work.
To critics it is inequitable because higher earners get a bigger benefit.
The flat rate option could either see everyone get just the basic 20 per cent boost to their pots at the outset, or if the Government was more generous it could set it at a higher level, to help lower earners taxed at the basic rate save more for old age.
The suggestion previously has been that a middle-ground of 30 per cent would be proposed, giving lower earners a bit more and higher earners a bit less.
Either way, those on 40 or 45 per cent wouldn't get back their full whack of tax any longer. These savers get the bulk of pension tax relief at present, although this is because they earn more and pay more tax.
Scrap 40% and 45% pension tax relief from a certain age
The Government could introduce a flat rate that kicked in only for older people, by stopping higher rate and additional rate tax payers from claiming relief on their tax returns once they pass a particular age.
There would be no change for older basic rate taxpayers, but richer older savers would be penalised.
Reduce the annual allowance for those over a certain age
The annual allowance is the total amount people can put in their pension pot every year and qualify for tax relief.
It is currently £40,000 for most people, but it is gradually reduced to £10,000 for those making between £150,000 and £210,000 a year.
This change could mean creating different levels of annual allowance depending on people's age, on top of operating the sliding scale for higher earners.
The problem here is that the annual allowance - and the lifetime allowance - have already been hacked back considerably. There are also worries that hitting pensions for higher earners has a knock-on effect for those lower down the ladder, as bosses lack the incentive to back pension contributions they can no longer benefit from.
Scale back employers' National Insurance exemption
The Government pays around £38billion a year of individual pension tax relief into people's pots, but also contributes an estimated £15billion a year to cover employer National Insurance exemptions.
It could opt to cut the latter, to make the main burden of any change fall on businesses and only indirectly on ordinary savers, although the cost would inevitably be passed on eventually via lower pay or fewer jobs.
How could changes affect pension savers?
Criticisms of a pensions Isa and flat rate of pension tax relief are well rehearsed given the ideas have been knocking around for several years.
But pension experts were quick to point out the practical problems, unintended consequences and unfairness of discriminating against savers based on their age.
People would have to save out of taxed income, and then trust the Government not to wallop them with tax again when they reach retirement.
The system would also be much less generous, give people much less of an incentive to save, and lead to smaller retirement pots due to less money going in at the outset and not benefiting from compounded investment growth.
Britain also ends up with two pension systems: a previous one of old-style pensions and a new one of pension Isas. This would be very difficult to administrate.
This would abolish for good the historical principle that the money that you put towards old age saving is not taxed no matter how much you earn - an idea that originated in the Finance Act of 1921.
Once introduced, the Government would also be able to fiddle with the rate whenever it wanted, so even if it was initially set at an advantageous level for basic rate taxpayers it could be reduced by successive Chancellors needing to raise cash.
Wealth is distributed unequally across age groups, and less well off older savers will feel hard done by if they are penalised to help young high fliers.
'Age is not a reliable indicator of wealth, health or ability to pay, ' says former Pensions Minister Ros Altmann.
'Some young people are earning huge sums, some older people are and always have been living on extremely low incomes. Favouring one age group will potentially alienate others.'
Tom Selby, senior analyst at AJ Bell, asks: 'How do you justify cutting pension tax relief for a doctor earning £60,000 in order to provide a tax boost for a City worker earning £500,000?'
Saving in later life
Most people can't afford to save very much into their pension in their early working years, but wage rises and inheritances often allow them to boost retirement pots in later life.
Alternatively, they realise that they haven't saved enough and put as much spare income into pensions as possible late on to try to make up for this. A situation such as this is particularly common with the self-employed.
'There are thousands of people trying to catch up on their savings in mid or later life for whom changing the goal posts would be damaging,' says Kate Smith, head of pensions at Aegon.
'Implementing such a system would disadvantage women who often have a period out of the workforce and then rely on making adequate retirement savings later in life.'
|Current pension contribution per month||Age 40||Age 50|
|£500 per month||£64,968||£31,237|
|£1000 per month||£129,935||£62,474|
|£2000 per month||£259,870||£124,947|
Impact study: AJ Bell modelled the effect on retirement outcomes of: 1) Scrapping higher rate pension tax relief for over 40s; 2) Scrapping higher rate pension tax relief for over 50s. The table illustrates how much older savers stand to lose out under each of the two reforms, in terms of a reduction in retirement savings by the time they reach age 65. In both scenarios the firm assumed post-charges investment growth of 4 per cent a year.
Many complexities would have to be ironed out. How to administer changes for different age groups across different types of work schemes would be a headache.
It could also mark the end of salary sacrifice schemes, where staff and employers boost pension payments in order to cut their National Insurance payments.
'Having different levels of tax relief based on age would risk layering extra complexity on an already complex system, says Selby.
'While it would be relatively simple to restrict higher rate tax payers from reclaiming additional relief via their tax return at a certain age, changes would need to be introduced to catch employer pension contributions, including salary sacrifice arrangements, so that they can’t be used to circumvent the new rules.
'Final salary pension schemes would also have to be looked at to ensure they are treated on an equal basis to money purchase pensions.'
Exodus from workforce
Older workers could bualk at being financial disadvantaged in the run-up to retirement, if for example their annual allowance was suddenly slashed after they reached a certain age.
'This would restrict the amount that they could pay into pensions, thus reducing the tax relief available to them,' says Gary Smith, chartered financial planner at Tilney.
'However, this could again create an issue for the Chancellor as senior staff in public sector schemes such as NHS staff and head teachers could opt to retire early to avoid penal tax charges that would be applied on contributions.'
Public sector schemes
A flat rate of pension tax relief would also cause problems for some members of public sector pensions due to the way they currently pay into schemes, according to Smith.
'Their pension contributions are deducted from their income before income tax is calculated, effectively providing them with higher or additional rate tax relief immediately. How could a flat rate tax relief be applied to these individuals?'
Copyright © Associated Newspapers Ltd. All Rights Reserved.
This article was written by Tanya Jefferies from This is Money (Daily Mail) and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to email@example.com.