Tuesday, 6 October 2015

Pensions - how Osborne can have his cake and eat it

Ructions in the world of pensions could see the Chancellor saving billions of pounds for the government, while stripping the rich of their lucrative tax relief, and giving an extra handout to the average saver.

Instead of everyone getting their tax back when they put money in a pension plan, 40% taxpayers would pocket a lot less.

Meanwhile, millions of basic rate payers would receive not just their 20% tax refunded; they would be given a bonus on top.

But now it is becoming clear how George Osborne could exploit such changes to help in his battle to control the deficit.

The pension cards were thrown in the air in the July Budget when Mr Osborne signalled that major reform was on the way. In the last few days calculations have been emerging which show the gigantic sums at stake.

This is how the ground is shifting: millions, 9 million eventually, are beginning to save in workplace pension plans for the first time under the government programme called Automatic Enrolment.

The development will have a dramatic impact on the Treasury's finances because the more money is saved, the more it has to pay out in tax relief.

Plus, it puts into stark relief what many see as the unfairness of giving more tax relief to higher earners, because most of the new pension savers pay the basic rate.

The other factor is that the new savers aren't putting aside nearly enough. The minimum to start with is a combined 2% of pay from both worker and employer, catastrophically less than the 12% or so needed for a decent pension.

So the priorities for reform have been: saving more, making it fair and getting a grip on the bill.

The cost of pension tax relief to the Treasury is considerable, around £27bn a year. With auto-enrolment, it will rise to over £30bn, according to the Pensions Policy Institute.

And the cost rises even further once you start tinkering.

People in the pensions business want a new flat rate of relief, so basic rate taxpayers get more while higher rate payers get less, with the most optimistic arguing for a flat rate of 33%.

The way this works, if you put in £2 the government adds £1, which would be easy to sell as "Buy Two, Get One Free"..

But that would push up the bill for the relief even higher, to more than £34bn.

What is more, the Pensions Policy Institute points out that such a system would encourage people to salt away greater sums in their pensions, earning additional tax relief.

This is a murkier area in which to make forecasts, but projections from the Institute suggest the overall cost could rise to £40bn or more.

More saving is one objective of the reform process, but so is trimming the bill.

In the current climate, George Osborne is unlikely to plump for a rise in the cost of relief from £27bn to £40bn. He would prefer to economise.

Setting the flat rate at a lower level of 25%, sellable to basic rate taxpayers as "Buy Three Get One Free", would do exactly that. It would reduce the cost to less than £25bn, netting the Treasury billions.

Taking the relief down to 20%, refunding tax at just the basic rate to all taxpayers would pull the cost below £20bn.

There are other options. The Chancellor could make a gain by clamping down on the way some pension contributions escape National Insurance, he could put tighter limits on how much you are allowed to put in a pension or he could get rid of pension tax relief completely and replace it with something else.

He could give us an inkling in his Autumn Statement next month.

But leaving the pension system as it is, doing nothing, is looking less and less likely, because the cost of supporting our pensions could just keep on rising.

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