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Call to scrap higher rate tax relief

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Higher rate tax relief on pensions is “costly and ineffective” and should be scrapped, a think thank has warned.

Centre for Policy Studies academic Michael Johnson comments come after rumours chancellor George Osborne may cut higher rate relief by reducing the annual allowance on contributions from £50,000 to as little as £30,000 in the Autumn Statement.

The pensions industry widely derided the policy suggestion, with several figures claiming any cut to tax relief would damage pension saving at just the moment the government is trying to improve it through auto-enrolment.

However Johnson, claimed in a controversial report that the £360bn spent on various tax reliefs has failed to boost saving.

He included relief on contributions, pension commencement lump sums, National Insurance contribution relief on employer contributions and relief on investment income in the £360bn figure.

In Costly and Ineffective: why pensions tax relief should be reformed, Johnson argued the Treasury’s cost of funding tax relief averaged a real 3.9% per year over the last decade, but that the average real annual return on all UK pension funds was 2.9% per year.

“Thus, the return on the Treasury’s co-investment with people saving for retirement, through the medium of tax relief, has been negative £17.5 billion,” Johnson said.

He said the tax incentives currently offered are “crude and misdirected towards the wealthy”, lacking in “emotional resonance”, and do not encourage saving in younger workers.

Johnson also claimed tax relief does not amount to deferred taxation, as only one in seven people who pay higher rate tax while working actually pay that rate when they draw their pension.

“From the Treasury’s perspective, this is a bad deal; higher rate tax relief is a huge cost (£7bn a year) to the state, not an investment,” Johnson said.

Johnson recommended a host of reforms to pensions tax relief in his report.

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He said the Treasury should scrap higher rate relief in order to save £7bn per year, but reinstate the 10p tax rebate on pension assets’ dividends and interest income, which would cost £4bn per year.

Johnson also suggested combining the annual contribution limits for ISA and tax-relieved saving into a single limit of £30-40,000, which he claimed would cut the cost of financial incentives by between £600m and £1.8bn.

Additionally, Johnson said the Treasury should replace the 25% tax-free PCLS with a 5% “top-up” of the pension pot, paid by the government to retirees in order to boost their annuity income, which he claimed would be cost-neutral.

CPS director Tim Knox said: “The chancellor faces many difficult choices in the forthcoming autumn statement.

“It is easy to say what he should not do: to dream up new punitive taxes which are inspired more by political signalling than by their financial contribution to the Treasury or by their impact on the economy.

“Rather, sensible reform of the financial incentives for savings could yield a double dividend of increasing long-term retirement savings while also reducing the immediate cost to the Treasury.”


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