Government's pensions tax proposals are better than Labour's but still need improvements

Last month the Government announced a new regime will bring a personal annual pension saving allowance of between £30,000 and £45,000, with at least a 40% rate of tax on pension contributions over the threshold. It will raise £3.5 billion for the Government and will potentially affect many final-salary scheme members and high earners.  

But Mercer argues four areas need to be addressed to ensure a healthy environment for the UK’s retirement system, and it suggests how to achieve this in its response to HM Treasury’s consultation process. The consultation closes on 27 August.

Deborah Cooper, head of Mercer’s retirement research group, said: "Certain elements of the current proposals will accelerate the demise of defined benefit (DB) occupational pension schemes unless changed – otherwise, employees on incomes just above the higher rate tax threshold could inadvertently become liable for tax charges greater than the amount of pension they have actually accrued.

"The loss of more DB schemes will precipitate a reduction in the overall savings level and increase the degree of risk individuals have to bear, resulting in more pensioners with insufficient incomes. This is not in the long-term best interests of the UK economy and will pull the rug from underneath the UK’s occupational pension system.

"The proposals also incentivise the current generation of senior management to drop out of pension provision. Hit those in companies who make the decisions on pensions and you undermine enthusiasm for the whole regime, to the detriment of us all."

Mercer believes the current proposals will inhibit employers’ ability to provide pension schemes that are strategically right for their business and that support the long-term wealth creation of their staff. The government risks introducing a penal tax law attacking the specific provision of long-term risk sharing / defined benefit provision, which will inhibit employers from doing what is right for their employees. It also believes that increasing the complexity and cost of DB pension provision will encourage employers to dumb down pension provision to the minimum acceptable level, which may not be in the best long-term interests of employers and employees, and the nation.
Mercer’s preferred regime would have the following four characteristics:

1. A reduced annual allowance with an annual allowance charge equal to the individual’s marginal rate of tax.
2. Age-related factors to convert defined benefit accrual into an equivalent ‘contribution’, which treats all employees fairly.
3. The annual allowance charge should be levied on current accrual only and should not be applied retrospectively.
4. Tax relief should continue to be granted at an individual’s marginal rate.

Cooper added: "Whilst there is a case for limiting the extent to which tax relief is available on pension savings, the tax system should encourage long-term savings plans, such as corporate pension provision, and not hinder them for short-term tax revenue purposes.

"This is not just a high earner issue – it will affect a wide range of employees. If the government’s proposals go through unamended, in some schemes the majority of members will find themselves exposed to an unpredictable and inequitable tax regime."