George Osborne’s reported gravitation towards a pension Isa model risks another Northern Rock says Hargreaves Lansdown head of pension policy Tom McPhail
Reports suggest the Chancellor is gravitating to a reform to pension taxation based on an Isa style system where the tax relief is restricted to just basic rate (20 per cent), but withdrawals are tax free.
This follows the announcement in last summer’s Budget of a review of pension taxation, with the results of the review due to be announced in the Budget on 16th March.
There are a number of reasons why this proposed solution is likely to run into difficulties.
Investors don’t trust politicians not to muck around with the pension system, with good reason. An Isa style reform with tax relief being scrapped in favour of tax free withdrawals would create the risk of a future Northern Rock style run on the pension system and the UK stock-market. Any hint of political interference in the future could result in billions of pounds being withdrawn overnight; it would be hugely unstable.
The offer of a 20 per cent top up, with tax free withdrawals looks superficially attractive, however any change to pension taxation will involve cuts to the tax relief available. This is likely to be particularly bad news for anyone who becomes a higher rate taxpayer towards the end of their working careers when they are most able to catch up on their pension funding. It would mean cutting the Annual Allowance very substantially, probably down to around £10,000. It would therefore become extremely difficult for mid to high earners to build a decent retirement pot over their working lives.
For a higher earner, it would mean exchanging 40 per cent relief on £40,000 for 20 per cent relief on £10,000; a loss of £14,000, in exchange for a paper promise from a politician which would depend on a future government for its honouring.
Mid to high earners are likely to look increasingly towards more esoteric investments such as VCTs, resulting in higher risk-taking.
The scheme would involve a transfer of costs from today’s taxpayers to those of the future, and so would exacerbate intergenerational tensions.
It would have to apply only to future contributions and would create a two-tier pension system, increasing costs and complexity for all involved.
We also anticipate that employers would may cut back on their workplace pension funding, limiting their contributions to the statutory minimums under auto-enrolment. This is likely to penalise the lower paid in particular as they rely more heavily on their employer for support with their pension funding.
This scheme might save the Chancellor some money but only at the expense of the country’s long term retirement plans.