Calls for reform of tax relief on pensions, the LISA and triple lock
30 July 2018
A ‘fundamental reform’ of pensions tax relief is needed with widespread acknowledgment that the current system is not an effective or well-targeted way of incentivising people to save into pensions, a new report by the Treasury Committee has found.
In the Household finances: income, saving and debt report, the Committee said the government should give serious consideration to replacing the lifetime allowance with a lower annual allowance, introducing a flat rate of relief and promoting greater understanding of tax relief as a bonus or additional contribution.
In 2016/17, the cost to the taxpayer of income tax and NICs relief on pensions was around £41bn. However, the tax relief offered has become less generous in recent years, with the annual allowance currently £40,000 against £255,000 in 2010/11. In tandem, the lifetime allowance has fallen from £1.8m to £1.03m.
The Committee said there was widespread scepticism around the effectiveness and fairness of tax relief.
Baroness Ros Altman, the Minister of State for Pensions from 2015 to 2016, told the Committee that tax relief is “poorly understood and poorly targeted.”
“If you wanted to encourage lots of taxpayer spending to incentivise saving, the people you would normally most want to incentivise are those who have least ability to save. The way tax relief works gives most incentive to those who are at the top end,” she said.
In 2015/16, 52% of the total income tax relief paid on pension contributions went to individuals earning £50,000 or above, up from 49% in 2010/11.
Michael Johnson, research fellow at the Centre for Policy Studies, strongly criticised the cost and effectiveness of tax relief and called for its abolition.
He said: “I would scrap all pensions tax relief, including employer NICs rebates. That creates a cash flow of about £46 bn a year. I would introduce a bonus structure that is an incentive disconnected from your tax-paying status. I would also bring down the annual allowance from £40,000 which is irrelevant to virtually everybody in the country, to a number between £8,000 and £10,000.”
Laura Suter, personal finance analyst at AJ Bell, said of the proposals: “Scrapping the lifetime allowance for pensions and controlling tax relief through the annual allowance would be a welcome development and stop people worrying about good investment returns resulting in a tax hit. If a flat rate of tax relief encouraged more pension savings it would be a positive outcome, but the report also concludes that tax relief does not work as an effective incentive to saving, so it’s hard to see how it would make a significant difference. Before such a radical overhaul to the system, we would want to see evidence that it would achieve the goal of getting more people saving for their retirement.”
Sir Steve Webb, director of Policy at Royal London, said simplification was the most important thing and rather than have several different allowances, the government could introduce a simple, perhaps lower, annual allowance. However, he warned that “tinkering” with pension rules needs to stop, with six cuts to limits on tax relief in just seven years, which has created difficulty for both financial advisers and the consumers.
The Committee has also recommended replacing the “unsustainable” triple lock system, which sees the state pension rise annually based on the highest of earnings, inflation or 2.5%, with an ‘earnings-uprating.’
In its proposals, the Committee said using an earnings uprating could result in a large rise in the number of under-savers and urged the next auto-enrolment review to explore the options for making up with private savings the shortfall that could result if the triple lock were abandoned in the future.
Life yet in the LISA?
In addition, the parliamentary committee of MPs said the Lifetime ISA should also be scrapped. It said the Lifetime ISA had received strong criticism for its complexity, perverse incentives, lack of complementarity with the pensions landscape and lack of popularity among the industry and pension savers alike.
It found that in promoting the product to retail investors, the government had failed to make clear that those withdrawing their money early stand to lose not only the 25% bonus but a fraction of their capital.
It said that while it welcomed the Minister’s commitment to clarifying the standards of disclosure on the government website, it was “deeply disappointed” that this still hadn’t been done two months later.
Baroness Altman showed support for the abolition of the Lifetime ISA, calling it “another mis-selling scandal waiting to happen.”
“If people start relying on ISAs and LISAs for retirement, they are bound to be pretty poor in their 80s,” she warned.
However, Skipton Building Society has urged the government to ignore the Committee’s recommendation, suggesting that it overlooks the hundreds of thousands of people already using the product to boost their savings.
Kris Brewster, Skipton’s Head of Products, said: “Originally, the Government aspired to see 200,000 Lifetime ISA accounts opened in the first wave of activity. At Skipton, in just over one year, we have opened over 112,000 accounts for our members. We believe the Lifetime ISA can make a real difference for people wanting to get on the housing ladder.
“There are several other providers offering stocks and shares LISAs, along with recent announcements of other financial organisations confirming their intent to launch a Lifetime ISA. We believe the consumer response and uptake of this product, plus the positive intentions which the savers have, demonstrate the success of the account and indicate a real consumer need for savings products which support home ownership.”
AJ Bell’s Suter also cautioned that scrapping the Lifetime ISA just 18 months after introducing it could dent consumer confidence in the savings market.
“Such a drastic move should be considered within the context of wider changes that could help savers,” she noted.
The Committee also looked at the triple lock on the state pension, saying that that while Government has committed to maintaining it to the end of this Parliament, were it to be maintained in the longer term, the state pension would rise relative to earnings indefinitely. “This is clearly unsustainable,” the report stated.
Government analysis has said that replacing it with earnings-uprating could result in a large rise in the number of under-savers.
The Committee’s report therefore recommended that the next auto-enrolment review “should explore the options for making up with private savings the shortfall that could result if the triple lock were abandoned in future.”
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