Is the pension-ISA doomed?

Will insurers keep the idea of a pension-ISA firmly on the ground?

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Pensions companies and insurers are slowly putting their thoughts together on the radical proposal to tax pensions like ISAs.

The green paper announced in the summer Budget looks at moving from an exempt-exempt-taxed regime for pension contributions to the taxed-exempt-exempt model of ISAs.

Insiders working closely with government tell me that chancellor George Osborne is ready to ditch pensions as we know them but the insurance companies don't seem as pleased with the idea.

Having spoken to a number of pension providers, they're very keen to point out that swapping pensions for ISAs is just one option, and a nuclear one at that. They say the option at the other end of the spectrum is to maintain the status quo, but the overarching feeling is this is a way to get insurers to agree with a cut in higher rate tax relief.

Cost conundrum

The shake-up of pension taxation is centred on cost and the fact that too much tax relief is paid for higher earners. Pension providers and insurers have long argued against cutting tax relief at 40% and 45% and one insurance bod told me that he believes the threat of scrapping pensions is enough to make the industry agree to a cut in relief.

As much as consumers and even the government didn't wish it were so, unfortunately the insurers do hold a lot of power, and if they're unwilling or unable to make changes to a new system of pension ISA, or Pisa as someone has already coined it, then what happens? They're already struggling to make the changes needed to make sure pension freedom works smoothly, this adds another layer of cost and complexity.

The other unanswered question is whether we will be running two pension systems – the existing one and a new pension-ISA system? And secondly, will people be able to switch between the two? If they can switch I'm assuming they will have to give back all the pension relief they received in order to take withdrawals tax-free.

This is a dangerous area as many people pay less income tax in retirement than they received in relief, and some pay no income tax at all. By giving up the relief to switch to a pension ISA, they would be worse off.

Of course the consultation should address all these questions but will the answers make the pension-ISA untenable?

Read more:

Could new freedoms be the end of pensions?

Would a £40,000 ISA allowance make pensions redundant?

Has Budget sounded the death knell for pensions?

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