The start of a new parliament is a good time to stand back and ask some pretty fundamental questions about the UK pension system.
Much of the complexity in the current system has arisen as a result of piecemeal changes, often because the government of the day was short of a billion or two to balance the books.
But the promised pensions review under a potential new government offers a long-awaited opportunity to think strategically about the system as a whole and thence to provide some stability over the medium term.
One element of a government pension review is likely to be pension tax relief.
With the main parties having pledged to maintain current rates of income tax, national insurance contributions and VAT, sources of additional revenue are likely to be in short supply.
As the bill for pension tax relief runs into tens of billions of pounds, it is hard to imagine that Treasury officials will not be sent away to come up with options for savings from this source, as well as to examine whether the money that is being spent could be better directed.
So, what might a reformed system of pension tax relief look like?
An important starting point is to be clear what the system is trying to achieve.
Fiscal purists would argue that tax relief is simply a way of moving tax from when money is earned (during your working life) to when you actually benefit from it (during your retirement).
Viewed through this lens, giving tax relief on the way in and levying tax on the way out of pension saving is ‘fiscally neutral’ and appropriate. But any other reliefs, such as tax free lump sums or the ability to pass on pensions free of inheritance tax, would not fit this model.
An alternative viewpoint is that pension tax relief could be used to reward and incentivise pension saving, particularly amongst those on lower and middle incomes who may otherwise end up with a very modest standard of living in retirement.
One way of doing this that is often floated – including by the current shadow chancellor in the recent past – would be to have a flat rate of pension tax relief regardless of income.
This would in part deal with the issue that the lion’s share of the bill for pension tax relief is currently spent on those on higher incomes, who have least need of a leg up.
Such a flat rate could be set at a revenue-neutral level, so that the overall cost of the system was unchanged, or, more likely, would be set at a level that provides a net uplift to the Treasury as well as doing more to help lower earners.
