Outlook: Why it is time to raid the pension piggy bank

David Prosser
Tuesday 21 June 2011 00:00 BST
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It has taken him more than a year, but our cash-strapped Chancellor of the Exchequer finally seems to have realised that pensions policy could make an important contribution to his efforts to get on top of the public finances.

Not public sector pensions, where the reforms are provoking such fury from the trade unions, whatever their rights and wrongs, and will not generate savings for the Treasury for many years to come. No, if the Westminster gossips are to be believed, George Osborne has something else in mind: a raid, as it would no doubt be characterised, on tax relief for higher-rate pension savers.

About time too. Cutting back on higher-rate tax relief would certainly be unpopular with the millions of savers who would be affected, let alone the savings industry, which earns big money from this racket. But in this age of austerity, the arguments for subsidising the pension contributions of higher earners to the tune of 40 per cent look tougher than ever to make.

To put the figures in context, the Centre for Policy Studies says the cost of pensions tax relief is about £30bn a year. That's the cost of paying incentives to all savers, including those on basic-rate tax and employers contributing on behalf of staff, but it equates to more than half the total budget of the education department, or a third of the NHS budget.

Moreover, the lion's share of this huge sum is accounted for by the cost of relief for the wealthiest savers. The TUC reckons the richest 1 per cent of the population grab a third of the tax relief. New caps on pension contributions will address the inequality to some extent, but we will still offer the largest incentives to save to those who are already most able to do so.

The pensions lobby argues that the idea that higher-rate taxpayers get more than their fair share is undermined by the fact that they go on to pay more than their fair share in old age – that they get higher-rate relief while contributing, but then pay higher-rate tax when drawing a pension.

That argument would have greater merit if the statistics did not show that only one in seven savers on the higher rate while still working continues to pay higher rate tax in retirement. And that's leaving aside the generous provision that allows pension savers to take 25 per cent of their funds as a tax-free cash lump sum on retirement.

We shouldn't cancel all pensiontax breaks – at least not immediately – although there does need to be more work on whether this systemof reliefs just encourages people to save cash in a pension scheme that they would have put by in any case. But there is a strong case for recouping the £7bn or so we spend each year on pension tax breaks for individual higher-rate taxpayers (not employers).

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