I\’m not sure this makes sense

Nor does it seem to be fair.

I’d simply abolish higher rate tax relief for pensions.

let’s be honest – pensions are just a savings scheme. That’s it: no more, or less. And it beats me why the savings of most of the richest in society (and I know about the new cap for the very wealthy) should be subject to double the rate of tax relief as all the rest in society – especially when it is estimated that this costs at least £9 billion a year.

When austerity is needed the savings of the rich do not subsidy. This is one law that definitely needs to be axed.

For while there is a subsidy there, it\’s not the one being highlighted.

Here\’s what happens with pensions and tax.

You save your money into a pension fund. This applies whether it\’s you putting cash in, your employer doing it on your behalf (pensions of this sort are best looked at as delayed compensation). On the money that goes in you get tax relief on what you put in at your normal tax rate.

This can indeed be described as a subsidy.

However, when you start taking your money out of your pension, when your pension starts being paid, you pay tax on that income that comes out of it.

So the \”subsidy\” isn\’t a straight such subsidy: it\’s rather a delay in your tax bill. Essentially, you get to save tax free, and thus make returns on both your money and the notional tax bill. This is nice, yes, for it means that you are earning returns, you are earning interest, on that delayed tax rather than it being spent this year on outreach diversity advisors.

But that subsidy does get paid back: because you\’re paying income tax on what you receive in pension.

One could imagine various flavours of fairness in such a system. Save tax free, pay tax on the income received (if, for example, as a matter of public policy, we would like people to save for their pensions: which we do). Pension savings must be made from post tax income and pension income is free of tax (again, if for public policy reasons we want to encourage people to save for retirement).

We could even have save for pensions out of post tax income and have income tax on the returns from pensions: essentially, do not have a pension scheme at all. No tax privileges, nada. In effect,  pensions saving is just like any other form of investment.

But it would seem wildly unfair to have a hybrid system. Where some people get tax relief on pensions savings and pay full income tax on income from a pension and others get no (or less) tax relief on savings but still pay full whack income tax on income from pensions.

Which is what Ritchie is suggesting. You don\’t get 40% or 50% relief on saving for a pension, only 20%. But you do have to pay 40 or 50% on income from a pension when you get it.

In order actually to be fair you\’d need to have a lower rate of income tax on income from pensions that didn\’t attract the original tax relief, wouldn\’t you?

15 thoughts on “I\’m not sure this makes sense”

  1. As you have stated, money goes into a pension and then back out, you pay tax on the withdrawal, therefore it is fair to not pay on the deposit.

    It needs to be taxed on withdrawals because sometimes the money is withdrawn by someone else (a spouse or dependent) and they pay the tax instead.

    What is being proposed is another form of double taxation, like inheritance, but instead the money could even stay with the same person.

    I suppose that does work, tax people twice and get more income – simples !

  2. It is worse than that. If you abolish the tax relief going into a pension scheme then you would not only be taxed on any gain but also on the principle for a second time as you pay income tax on all the money paid out.

    Contrast with an investment made directly into bonds or shares from post tax income. Here you only pay tax on any interest or gain but not again on the initial principle.

    If one was to implement this idea it would make pensions the least tax efficient way to save.

    Tim adds: A very good point. For of course your annuity converts capital into income, doesn’t it.

  3. Something else that doesn’t make sense is his commenting policy.

    “Those who wish to argue that tax havens / secrecy jurisdictions are good things may do so, but not here. Likewise those promoting neoliberal economics may do so, but not here: propagating the delusion that an economy can be accurately modeled using counterfactual propositions about its nature is not something I wish to partake in, and will not allow.”

    That last sentance is especially telling. I get the impression that that is exactly what he is doing himself. 🙂

  4. The idea that someone might get tax relief of 20% on the way in, but pay marginal tax at 20% (or whatever the standard rate is in the future – probably higher) or 40% or 50% on the way out is ludicrous. On the other hand, I must admit that I don’t see why it makes sense to incentivise high-earners to save in the particular box labelled “pension scheme” – these are people who will save anyway, one way or the other. The coalition’s compromise of just limiting the incentivised savings to £3ok p.a. (or whatever the limit turns out to be) seems to be a reasonable, practical solution pro tem.

  5. Of course, one can pay into a pension reducing higher rate tax, and then when being paid back only be paid enough money to pay basic rate tax.

    Someone out there must have done some modelling on how much tax is paid overall in a variety of situations. I’ve not been able to find anything so far though.

  6. I was gonna post on this myself, but I’ll comment here instead.

    Abolishing higher rate pensions relief is a surefire way to ensure that bosses lose interest in maintaining pensions for their staff. Once bosses can no longer participate in a tax efficient way, there’s no incentive for them to offer any more than the legal minimum. Which from 2012 will be a 1% contribution (to rise to 3% by 2018).

    This isn’t so much cutting off your nose to spite your face, it’s hacking off all of your limbs to spite your body.

    Coalition plans to reduce the amount you can pay in in one year (raised by Labour… yes, Labour to over GBP200k a year) to more like GBP30k would help a lot. And otherwise you can just let the lifetime contribution limit of GBP 1.8 million run its course. That will soon sort out the fattest of cats if they overegg their pension contributions.

  7. The Pedant-General

    ” On the money that goes in you get tax relief on what you put in at your normal tax rate.

    This can indeed be described as a subsidy.”

    NO IT BLOODY CAN’T.

    Not at all.

    A subsidy is when the state uses money forcibly extracted from taxpayers on pain of imprisonment and gives it to someone who has not earned it but merely made a case that should be given a handout.

    That is so utterly completely not the same as the state deciding to reduce the amount it forcibly extracts from you on pain of imprisonment on money you have actually earned yourself.

    ESPECIALLY when this tax break is specifically hedged about so that it can only be used to reduce the burden that you might otherwise place on the state in later life.

    TAX BREAKS ARE NOT SUBSIDIES.

  8. Woah! You’re all making the same big mistakes.

    1. Of course the nominal value of the income tax ‘saved’ by higher rate taxpayers daft enough to pay into a pension scheme is enormous (about half the total value of the tax saving). But you, like most people, assume that the total value of cash in plus tax break is paid out again as pension. It’s only slightly more than half, as the ‘pensions industry’ soaks up the rest in fees and commissions, and what little is paid out again is usually only subject to basic rate income tax.

    So tax breaks are very much a subsidy – FOR THE ‘PENSIONS INDUSTRY’!!

    2. You ignore National Insurance savings on way in which don’t apply to pensions on way out.

    3. I agree that there should be no higher rate relief, but neither do I think we should have higher rate tax, fair’s fair.

    4. Ultimately, people will make better decisions if they do their own investing, rather than let the usual suspects in the city run their pensions and invest in companies which their mates run. So really, we shouldn’t have tax relief for pensions at all, which would enable us to get rid of higher rate income tax entirely and probably hike the tax free personal allowance to £10,000.

    5. If nothing else, most people would be far better off paying off their mortgages much quicker than investing in shares (the after tax return is probably better and is certainly much more ‘secure’).

    What’s not to like?

  9. As has been pointed out, the tax on the way out is applied to the capital sum, not the earnings. If you remove higher rate tax relief I will stop my contributions and switch to savings, which grow tax free in an ISA and where I can draw down my own savings without tax.

    By the way, the high annual limit on pension contributions was put in place to allow someone with a windfall to be able to catch up on previous years of low contributions. The carry forwards and carry back provisions were lost as a consequence. If you want to drop the contribution levels you’d better bring them back again.

  10. Kay Tie – you make a very good point about the high annual limit on pension contributions being put in place to allow people to catch up on previous years of low contributions.

    There are plenty of risk-takers out there who have built businesses and made no significant pension contributions for many years.

    If the ability to make tax free single large contributions is taken away, then the clear message from the Government is “don’t bother taking risks in the UK as even if you succeed you won’t be able to make up any pension shortfall without us taxing you twice”. I would advise anyone thinking of starting a business in the UK to seriously consider setting it up in another, more business friendly jurisdiction.

  11. as Mark points out, the returns from pension funds are about 2-3% lower than comparable unit trusts run by the same management groups – fidelity, M&G, Gartmore etc. That 2-3% makes a LOT of difference compounded over 30-40 years.

  12. You are ignoring the subsiy that comes from the fact that currently, while the pension is only taxable on receipt, the contribution has been allowed against the paying companies taxable profits.

    Given the current size of the UK’s pension funds, that is one hell of an interest free loan/ subsidy.

  13. Regarding deferral of income tax, there are two things that haven’t been mentioned.

    Those on a different (specifically lower) marginal tax rate in retirement than employment get tax back. So someone going from 40% in employment going to 20% in retirement are only deferring 1/2 their tax (and are getting the remaining 1/2 rebate in their pocket.) Or those on 20% in employment will usually have some extra tax allowance that will be soaked up by some of their pension, which again won’t be taxed.

    Secondly, no-one has mentioned the 25% tax free lump sum, so essentially 25% of the rebates going into the fund (plus gains) aren’t getting taxed when they come out.

  14. The Pedant-General

    “Those on a different (specifically lower) marginal tax rate in retirement than employment get tax back”

    No they don’t. They have had less tax taken from them. This is not remotely the same thing.

    If you do less work this year and thus pay less tax, have you been subsidised by the amount of tax thus reduced? Of course you bloody haven’t.

    Subsidies are when someone gives you money you have not earned in good honest voluntary exchange of some form or other.

    You have earned your money. The state taking less of it is therefore a not subsidy – it is the state taking slightly less of what you have earned.

  15. ““Those on a different (specifically lower) marginal tax rate in retirement than employment get tax back”

    No they don’t. They have had less tax taken from them. This is not remotely the same thing.”

    Whatever – so I missed out the word ‘effectively.’

    Depends on where you’re looking at it from however. If you took that money while working, you’d be taxed at 40%, if you defer taking it you’d be taxed at 20%. You ‘effectively’ get 20% ‘tax back’ by deferring.

    Or, from another POV, since you’d be taxed on it if you took it now, but you do in fact get that tax back if you stick it in a pension, my statement (as it stands) is perfectly correct. You just get taxed on it later.

    Your pedantry, is just that. Pedantry. For the sake of it, it would appear.

    “The state taking less of it is therefore a not subsidy …”

    This I *will* call you on.

    My post was strictly about tax deferral and the ‘TFLS’ upon claiming your pension, and I specifically, and deliberately, did not address any points about subsidy.

    Any pedantry you found in my post regarding subsidy is strictly an imagination of your figment.

    HTH.

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