Pensioners are faced with an excruciatingly dysfunctional tax administration system. In the past, the OTS has made bold proposals, such as merging national insurance and income tax, and reforming inheritance tax through trusts and capital gains. Though the latter proposal has been kicked into the long grass, there is potential for similarly forward thinking about pensioners’ taxation.
Andrew Meeson, president of the Association of Taxation Technicians (ATT), says the first step would be to see if the administration of tax can be made to work properly.
‘The complexity does not come from the pensions side,’ he says. ‘It is the detail and administration of the pension from a taxation perspective that causes problems. For example, the application of PAYE does not work properly, as the Department for Work and Pensions (DWP) does not keep HM Revenue & Customs (HMRC) up to speed.’
This lack of communication from the DWP to HMRC often results in pensioners facing bills for unpaid tax on mispaid credits dating back several years.
Should pensioners be taxed?
As well as working out the ‘grit in the system’, says Meeson, the review is free to look at whether pensioners should be taxed at all.
‘There is the possibility of changing the taxation of pensions from EET [exempt, exempt, taxed], where contributions and growth are tax-exempt but there is taxation on income, to ETE [exempt, taxed, exempt], where only growth is taxed. So there is some kind of taxation in the middle. I believe the fact income will be taxable is an obstacle to saving,’ says Meeson.
‘Why not just put it in an ISA? Why put it into a pension when it just comes out in dribs and drabs? The same goes for auto-enrolment. If I were a low-paid worker, I would opt out, and by low paid I mean a basic rate taxpayer.’
For older savers, the question might be one of whether auto-enrolment is an opportunity to get back on the pensions wagon, or are they better off putting their money somewhere else?
‘Older people will get less, but it is all about triviality. You would get the 25% tax free of £18,000 taken as cash. This is an effective tax rate of 15%. But is it better than an ISA? This is an interesting question. I think sorting out the way pensioners are taxed would make pensions a bit more tempting for lower earners.’