Five pension problems the Treasury needs to focus on

The Treasury has confirmed the 2019 Budget setting out this Government’s fiscal agenda is scheduled for 6 November.

While there is no guarantee this administration will actually survive that long, there are various issues demanding Chancellor Sajid Javid’s attention.

1. Scrap the pension tax taper

The strains being placed on the NHS as a result of the pension tax taper means reform here is now urgent. Rather than tinkering with scheme rules to address this problem – which is putting patient safety at risk – the Government needs to bite the bullet and abolish the taper altogether. This would cost around £1billion a year, a relatively small price in national spending terms.

Overall the UK’s pension tax system is in a bit of a mess and requires a fundamental overhaul.

Ditching the taper should act as a kick-start for a root-and-branch review aimed at simplifying the tax rules and building on the early success of automatic enrolment by encouraging more people to save for retirement.

2. Ditch the money purchase annual allowance

The UK’s system of pension tax allowances are poorly understood and can create perverse incentives.

While the flexibility created by the pension freedoms has been embraced by savers, those who access taxable income from their fund are dealt a significant blow as their annual allowance is cut from £40,000 to just £4,000.

This punishment is far too severe and flies in the face of both the pension freedoms and changing working patterns. Furthermore, it creates a huge savings constraint on people at a time when many will be looking to make up for years when they have failed to contribute to a pension at all.

This will particularly hurt those in their 40s or 50s who have missed out on the glory years of defined benefit provision and won’t benefit from automatic enrolment to the same extent as younger savers.

It is particularly cruel that the ability to carry forward unused allowances from the previous three tax years is also lost when the money purchase annual allowance is triggered. The fact it is also poorly understood means the risk of people accidentally scuppering their retirement plans is high.

3. Urgently review the taxation of pension freedoms withdrawals

The Government’s policy of overtaxing people the first time they flexibly access their pension risks causing confusion at best and serious detriment at worst.

Approaching £500million has now been reclaimed by savers who have been overtaxed via official forms provided by HMRC.

However, anyone who doesn’t fill out one of these forms risks being left short-changed until the Revenue pays them back.

Rushing in the introduction of the pension freedoms without first ensuring the tax system worked in this brave new world was a mistake. The Government must now accept this and prioritise finding a better system that works for savers.

4. Address the automatic enrolment ‘net pay’ lottery

The success of auto-enrolment risks being undermined by a flaw in the system which means the lowest paid workers risk missing out on pension tax relief.

The flaw exists because of the gap between the auto-enrolment earnings trigger of £10,000 and the personal allowance, currently set at £12,500.

Net pay schemes pay members’ tax relief by taking pension contributions before tax has been deducted, meaning taxpayers receive relief at their marginal rate automatically. Unfortunately this means if you pay no income tax, you get no tax relief.

This cruel lottery has existed for too long and needs to be addressed.

5. Cut the Lifetime ISA exit penalty

The Lifetime ISA was introduced in 2017 with the dual aim of helping people save for retirement and boosting the property purchasing power of younger generations.

The product has proven popular so far, with around 300,000 accounts opened, but the Treasury’s insistence on imposing a 25% exit penalty when someone accesses their fund for anything other than their first home purchase or from age 60 demands a rethink.

A charge of this magnitude is unfair and entirely out of step with the FCA’s agenda for the private sector in recent years. Reducing the penalty to 20% - so it’s aim is simply to recoup the Government bonus – would make the Lifetime ISA much more attractive to savers.

These articles are for information purposes only and are not a personal recommendation or advice.