New pensions reforms: tax raids are the enemy of sustainability

16 July 2015

George Bull

The proposed move to an ISA-style tax treatment of pensions would have huge benefits, and could produce a tax windfall as high as £40bn a year. So what’s the potential downside of this move?

On 1 July 2015 the House of Commons Library published two briefing papers which paved the way for broader pensions tax changes for the higher-paid. One week later, on Budget Day, the Treasury found itself having to deal with a major change of direction when it rushed out a consultation document opening the door to a pensions regime strongly reminiscent of ISAs, with contributions made out of taxed income and withdrawals made tax-free.

ISA-style pensions exhibit the desirable hallmarks of simplicity, transparency and sustainability, and increase emphasis on personal responsibility. Early estimates suggest that the associated elimination of pensions tax relief could produce a tax windfall as high as £40bn a year for the Exchequer - 70 per cent of that paid by the top 20 per cent of taxpayers.

Moving to an ISA-style tax treatment of pensions would certainly be radical. If politicians could resist meddling as each successive Finance Act comes round, the new regime would stand a good a chance of meeting the tests of simplicity and transparency. It would be much more attractive than the current complex regime and should encourage personal responsibility, and be powerfully redistributive with high-income groups losing substantial tax benefits.

Now here’s the difficult bit. The Treasury has identified sustainability as one of the principles of reform. Following the epic precedent set by Chancellor Gordon Brown, we’re all used to the post-Budget headline 'tax raid on pensions raises billions for Treasury' or similar. Tax raids are the enemy of sustainability.

The real worry on moving to an ISA-style system is another tax raid if a future government can’t keep its hands off the value of funds accumulated in these new-style pension pots, deciding to charge tax on subsequent withdrawals.

The Summer Budget’s change to tax credits reminds us that sound plans driven by certainty, transparency and fairness can founder when a new government changes the rules. Whatever emerges from this consultation, the Government can’t promise those who might spend decades contributing to a new regime out of post-tax income that they won’t suffer a tax raid and end up paying tax on withdrawals after retirement.

Some contributors may consider contributing to offshore funds hoping to escape a future tax raid. Look before you leap: however simple the new pensions rules are supposed to be, they are almost certain to be hedged around with complexities designed in part to keep the funds within reach of the taxman should a subsequent government change its mind. Recent QROPs changes and today’s HMRC announcement ‘Offshore tax evaders to face tough new criminal sanctions’ remind us that even legitimate investment overseas will be in the taxman’s spotlight.