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Summer Budget: pensions could be taxed like ISAs

Chancellor George Osborne is consultation on radical changes to pension taxation.

 
Summer Budget: pensions could be taxed like ISAs

Pensions could be more closely aligned with ISAs to allow retirement income to be taken tax-free.

In the summer Budget chancellor George Osborne announced the publication of a green paper that sets out sweeping reforms to the way in which pension savings are taxed and people save throughout their working lives.

Under the changes, that the Treasury plans to consult on, the taxation of pensions would be brought in line with ISAs.

At the moment, pension contributions receive tax relief on the way in, growth within the pension is tax-free but income tax is paid on income on the way out; known as exempt-exempt-taxed (EET). Retirees are entitled to take 25% of their pension tax free on retirement, known as the tax-free lump sum - the remainder of the income is taxed as income.

 ISA contributions are made out of income that has already been taxed, the growth in the ISA is tax-free and withdrawals from the ISA are tax-free; known as taxed-exempt-exempt (TEE).

Under the proposals set out by the consultation, the pensions system could be changed to a TEE structure where individuals would make contributions out of taxed income, the government would provide a top-up akin to tax-relief provided now, and then the income in retirement would be tax-free.

The consultation paper said ‘the government is interested in views on the various options that have been suggested for how the system could be reformed’.

‘These range from a fundamental reform of the system – for example moving to a system which is TEE and providing a government top-up on contributions – to less radical changes, such as retaining the current system and altering the lifetime and annual allowance, as well as options in between,’ it said.

'Pensions could be taxed like ISAs,' said Osborne in his Budget speech. 'You pay in from taxed income - and its tax free when you take it out. And in between it receives a top-up from the government. This idea, and others like, need careful and public consideration before we take any steps. So I am today publishing a green paper that asks questions, invites views, and take care not to pre-judge the answer.'

The plan to reform is part of wider concerns about the level of pensions tax relief being paid out. Currently, savers receive tax relief on their contributions at the highest rate of income tax they pay - so a higher rate earner will receive a 40% boost to their pension contributions from the government. This has been widely criticised as the wealthiest receive the highest level of tax relief.

The government has made changes to the annual and lifetime pension allowances to limit the amount of tax relief paid but now it wants to go further.

In this Budget it will also severely restrict the tax relief for those earning more than £150,000 or more by cutting the annual allowance from £40,000 to £10,000. For every £2 earned over the £150,000 threshold, the annual allowance will be reduced by £1 meaning those earning £210,000 will have an annual allowance of just £10,000.

In the consultation, the government said the total cost of tax relief was £50 billion in 2013/14.

'The government has sought to manage this cost through the lifetime and annual allowances and in doing so is projected to save around £6 billion per year,' said the green paper. 'The government has also significantly restricted the amount of pensions tax relief that goes to additional rate taxpayers, thereby making the system more progressive - a trend that will be furthered by the introduction of the tapered annual allowance for higher earners.'

8 comments so far. Why not have your say?

Law Man

Jul 08, 2015 at 18:59

Taxed-Exempt-Exempt is clearly better for HMG as it receives tax today rather than in 0-40 years time. It is worse for the investor as the capital invested over the 0-40 years is 20-45% less.

However, then there is mention of HMG adding something to each contribution: so it all depends how much is added.

Would it not be simpler to keep the present scheme with a flat 30% tax credit on contributions?

Will HMG reduce the system of lifetime limits and tapering relief, while putting an annual limit on contributions (with carry forward)?

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chazza

Jul 08, 2015 at 20:45

With a TEE system, how could employers' contributions be treated? If as a taxed benefit, it would be a strong deterrent to pension saving, especially for anyone repaying a student loan at 9% of salary above £15,000 or (new scheme) £21,000 p.a.

I'm inclined to agree that a flat 30% allowance on individual contributions to pension / superannuation schemes would be simplest, but then there is no justification for the limited lifetime allowance, and more justification for taxing pension payouts as income.

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andy

Jul 08, 2015 at 23:02

I do not see why 30% relief would be better - this is not tax exempt but tax deferred. There would need to be a system which resolves the anomaly of 30% tax deferred being turned into 40% tax at the end.

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chazza

Jul 08, 2015 at 23:16

andy,

because one can take 25% of pension pot tax free, a nominal tax rate of 40% is effectively 30%. Meanwhile, the capital gains and income within the pot have been free of tax, so a pension would still be a relatively attractive option, especially if employers / government are making contributions too.

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Danny Lovey

Jul 10, 2015 at 14:27

Whilst I can understand why George Osborne sees the need for a Green Paper - and he is quite right to do this, the end is in sight for the levels of tax relief on Pensions received hitherto, which is clear from this budget. I was always asked the question - which was best a Pension or an ISA? No easy answer to that of course as it very much depended on peoples, employers or if self employed etc and earnings/taxation to reach a conclusion, but from my own personal experience I did both and generally speaking found that most people it would also suit. With ISA's (although you do not get tax relief on money going in) you have the complete freedom of being able to draw funds out without worrying about paying tax, also do not have to wait until retirement, which gives an advantage on this score. With the Pension of course you only get 25 percent out tax free. I suspect that George Osborne is trying to square the circle here, so that neither has a clear advantage over the other, but just 'choices' on how to take your funds out of the pot, either the pension or ISA way, and by doing this also reducing the amount of tax relief given, which all seems fair enough to me for after all he has to reduce the deficit and is committed to reducing welfare payments, so there is a need to tackle both ends.

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uncommercial

Jul 11, 2015 at 10:08

I don't believe this is anything but more politically motivated short termism from ambitious Osborne. His only interest is boosting short term revenues at the cost of dumping on future governments.

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Danny Lovey

Jul 11, 2015 at 12:41

Dear uncommercial

Without wishing to go into some political debate, your views could not be further from the truth of what Mr Osborne is trying to achieve.

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Gill Pelosi

Jul 11, 2015 at 22:49

Uncommercial

Spot on in my view

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