Cut tax-free cash for a fairer pensions system
The pensions tax relief system is skewed to benefit high earners as everyone receives tax relief on their contributions at their highest rate of income, paid as a pension contribution top up by the government, meaning those earning £150,000 a year are receiving 45% tax relief compared to the 20% received by those on an average salary of £26,000.
In taxing the incomes of the rich more, this is the trade off, they are given more pension relief. There has always been an argument for reducing the highest earners' tax relief on the basis that they are the ones that benefit most from it rather than the majority of people on a normal wage.
However, while it always gathers speculation around Budget time no party has yet made the leap, probably because the insurance industry is anti a change – it would be a difficult and costly administrative challenge for it.
A recent report by the IFS also challenges the merits of scrapping higher rate reliefs, saying that actually the benefits and costs for the wealthy are lower than HMRC estimates.
What the IFS does think is a better idea, and probably easier to implement, is restricting the amount of tax-free cash that can be taken out of a pension.
At the moment 25% of a pension can be taken as tax-free cash. This is one pension bonus that people really enjoy and as the lifetime limit on pension contributions is currently £1.25 million, the maximum tax-free cash that can be taken is £312,500.
This is a huge sum that receives tax-relief on the way in – so essentially free money from the government – but is not taxed on the way out.
There is certainly an argument for reducing the tax-free cash sum - not percentage - by half or even less to ensure that the wealthiest pay back some of the large amounts of tax-relief they have benefited from without penalising those with more modest pensions.
We do need incentives for people to save into a pension and tax relief will remain but the country cannot afford to keep providing huge double tax breaks to the wealthiest who are benefiting more than the average person.