The dream of the pension-ISA is over

The dream of a pension-ISA hybrid are pretty much over and the suggestion may have been a red herring all along.

In its pension consultation, which wraps up next week, the government offered the pensions industry the choice of doing nothing to the current system, cutting higher rate tax relief for higher earners, or scrapping the whole system and bringing in a pension that is taxed like an ISA.

It certainly set the cat among the pigeons but I can't help but feel a bit cynical about the whole consultation.

According to my insurance sources, HMRC has already been around asking insurers about the practical application of changing the rates of tax relief for higher earners, and even bringing in a flat-rate tax relief.

These meetings happened before the consultation was closed, so what are we to take from this?

Well, I think that the pension-ISA was never really an option; it was a red herring from the government. Why would it do that, you ask? Because despite the need for reform of higher rate tax relief on pension contributions being on the cards for years (the Tories aren't the first government to want to do something about it) the pension industry has always pushed back against it.

Now, with a pension-ISA in the mix, a cut to higher rate relief doesn't seem as bad. The government threw in the nuclear option of a brand new tax system for pensions and it had exactly the reaction it wanted: the pension industry is now backing a cut to tax relief.

It's a canny move, but unfortunately there are a lot of savers out there who will be disappointed to learn that they won't be able to save into an ISA-style pension, one that would provide them with more access to their money.

The good news though may be for 20% basic rate taxpayers if a flat rate of relief comes in. A 30% rate was backed by former pensions minister Steve Webb and a 'buy two get one free' 33% relief has been discussed in pension circles. This means more bang for your pension buck.

And even if you're a 40% higher rate taxpayer, you're unlikely to lose out that much because unless you're extremely wealthy, it's likely that you'll be paying 20% tax in retirement so you win too.

Whatever way it's sliced, reform of tax relief is needs. It's a shame the government was forced to use games to get the industry to agree.

Read more:

Is the pension-ISA doomed?

Budget 2015: pensions and savings changes explained

Has Budget sounded the death knell for pensions?