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Some numbers are true and yet irrelevant. In 2022-23, for example, those paying the higher and top rates of income tax received the bulk of tax relief on pension contributions. Specifically, 17 per cent of taxpayers paid the 40 or 45 per cent tax rates, while also receiving 63 per cent of income tax relief on their pension contributions. It sounds unfair.
The true inequity, however, is different. What the statistic omits is the more relevant fact that higher and top-rate taxpayers also paid 69 per cent of income tax in 2022-23. They therefore failed to get their fair share of tax relief on pension contributions.
While it is easy to throw around statistics to justify reforms, any changes to pension taxation should focus on broad principles. These include the idea that income should roughly be taxed only once, either when earned or when received in retirement. Any reform should treat older people who have already benefited from pension relief similarly to those working and contributing now. Changes should not amplify the horrible incentives in the UK income tax system. Finally, any reforms should be practical to implement for both defined benefit and defined contribution schemes and for both private and public sector workers.
The good news for chancellor Rachel Reeves is that against these principles, the tax system is currently too generous. Sensible reforms can be married with raising money for the exchequer. But the only way of achieving all these principles is to reduce the favourable tax treatment when pensions are paid rather than when they are being built up — anything else exempts older workers and pensioners from the pain.
It would mean cutting, preferably to zero, the 25 per cent of pensions in payments (up to £1,073,100) received free of income tax. The Institute for Fiscal Studies has suggested removing about 40 per cent of this to raise £2bn a year in the long run, but eliminating the benefit completely raises around £5bn a year.
Also unjustified are the tax perks on pensions when someone dies. Unlike today, income from pensions should always be taxable if they have been inherited.
There is also a case for ministers to start progressively charging employee national insurance contributions on the receipt of private pensions, but this would be much better achieved in a gradual bigger tax reform that merged employee NICs with income tax to create a single and unified tax on income from all sources.
The reforms I have suggested would maintain incentives to work, to save and not to retire early: higher taxes on pensions would mean people working longer to receive a set retirement income. All of this is far preferable to the more common calls to provide less favourable tax relief on pension contributions, for example by restricting relief to a specific rate such as 30 per cent.
The current income tax system has absurdly high tax rates at £60,000, where child benefit is withdrawn, and £100,000 where childcare benefits and the personal allowance begin to be taken away. It offers huge incentives for people with incomes somewhat above these levels to shovel the excess into personal pensions.
But encouraging more pension saving is not the worst distortion imaginable. Restricting pension tax relief would force people to face these high marginal tax rates — the likely choice for many will be to work less, harming their current and future incomes, the economy and government revenues.
We know from previous restrictions of pension tax relief, particularly in the NHS, that working less is a choice many make when faced with tax rates over 60 per cent. Reeves can raise some revenues judiciously from excess generosity in the pension tax system. She can also do a lot of harm. Obviously it is better to do the former.
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