The ongoing summer of sport and politics reminds us that timing is everything. Timing of the winning penalty. Timing to the millisecond when winning an Olympic gold. Timing of the election.
Timing of when to tax future pensions? Well, that is a £20bn a year habitable planet decision. In this case the time – with the government’s pension reviews just beginning – is now. So, while we wait for the paralympics to start, let us dive in.
Better timing
Changing when pensions are taxed could increase government investment by a staggering £100bn over a five-year parliamentary term, as we described in our recent paper. Savings this high with no impact on company profits, no impact on pensioner pockets and with the potential to boost UK growth and our path to net zero; surely there must be a catch?
What does the government currently spend incentivising pensions?
Answer: £71bn a year via income tax relief (£47bn a year) and employer national insurance relief (£24bn a year).
How would it work for savers?
Let us take Sam, on £30,000 a year, 15 years to retirement and paying £1,500 into a pension.
| Current tax timing | Change tax timing |
Cash from Sam | £1,500 (gross) | £1,200 (net) |
Government bonus | Nil | £75 |
Investment returns (5% a year) | £1,500 | £1,275 |
Total at retirement (gross) | £3,000 | £2,550 |
Tax free cash | £750 | £750 |
Tax on pension payments | £450 | Nil |
Net pension payments | £1,800 | £1,800 |
Total returned to Sam | £2,550 | £2,550 |
Importantly, the level of take-home pension for Sam stays the same, only the timing of tax has changed. The same could be true for all earners, regardless of salary and without unfairly penalising one group, simply by adjusting the proposed government bonus.
But implementation would be material. So, is it worth it?
Unlocking sustainable UK Growth
The Labour government plan for UK growth is ambitious. If Rachel Reeves is going to unlock growth, and pull off net zero by 2030, we will need £50bn a year. That is orders of a magnitude bigger than the planned national wealth fund. Radical change, growth and frankly more money will be needed.
Pensions have a key role to play and, in tandem, retirement could be improved for many.
Better pensions – what needs to be done?
Here is a flavour of the problems to solve.
- Inadequacy. Most people are not saving enough for their retirement. Hymans Robertson found that an average earner with minimum contributions has only a 1 in 3 chance of achieving the Pensions and Lifetime Savings Association's moderate standard of living.
- Pensioner poverty. While progress has been made, an estimated 1.9mn pensioners are living in poverty.
- Including the self-employed. Only 1 in 7 of the self-employed are saving to pensions.
- Inequity. For example, there is a 35 per cent gender pensions gap.
The challenge is that to solve these problems costs money, of which there is not a lot, but £20bn a year would change things.
What about flat rate relief?
There have been calls for transformational change albeit via flat tax relief for pensions or offering cash as an alternative. There are others, and there will be more, as summer recess comes to a close.
Reforming tax that will impact outcomes can have unexpected consequences. For example, introducing a flat rate of relief may lead to higher earners opting out of pensions, which would impact employers engaging with pensions, which might lead to levelling down for all workers.
Happily, pensions are an intergenerational social contract. They do not need overnight transformation of who gets what or how much they get. But they must evolve from what we have. This will be transformational, but in a patient, evolutionary way where we are guided towards sustainable outcomes.
