Pensions, taxes and the death of certainty

24 February 2016

George Bull

Arguments continue as to what the most appropriate tax regime should be for UK pensions, with some seeing the pensions ISA as the answer to the problem. Either way, could the tax-free lump sum end up an early casualty in the ‘battle of the pensions’?

It’s said that truth is the first casualty of war. In the same way, certainty is now dying under the crossfire of arguments and counter-arguments about the appropriate tax regime for UK pensions. With high-earners continuing to find themselves facing ever-greater demands to pay more tax, the pensions industry wondering what kind of future it has and employers unsure how to meet HMRC’s demands, opposing forces in the battle (it’s been going on for so long that perhaps it should be called a war) are beginning to assemble along clear lines.

First, we have the army which is rallying around the flag of keeping the current system roughly as it is, but bringing in even more restrictions on pensions contributions while also doing away with the ‘tax-free lump sum’. That last step alone would cause massive disruption to hardworking families up and down the country who have been doing their best to plan responsibly for post-retirement income and may now find they have to pay extra tax bills unless these changes are phased in very slowly.

On the other side, the flag fluttering over the assembled troops bears the legend ‘PISA’ – the pensions ISA. If this army wins the battle, the old regime will be swept away, to be replaced by a new form of ISA, the pensions ISA. Details are skimpy but this would see a dramatic move from tax exemption for contributions, exempt growth within the fund but taxable pensions (E-E-T) to pension contributions paid out of taxed income, tax-exempt growth and tax-exempt withdrawals (T-E-E). 

Now we hear that the Institute for Fiscal Studies has stated that a one per cent increase in consumer spend would result in three quarters of a billion pounds in additional VAT, which equates to 0.1 per cent of tax revenues. So if the lump sum is maintained without being taxed and pensions are paid at a living wage, would this result in additional nominal consumer spend? If so, would this increase the tax yield, offsetting any expected loss in revenues by removing the tax breaks altogether? 

Either way, could the tax-free lump sum be an early casualty? Jackie Hall and Bill Longe look at the detail.

If you would like to discuss any of the points raised, please contact George Bull or your usual RSM contact.