Reforming the taxation of pensions could raise an extra £10.8bn a year, according to an influential think-tank, which has attacked an existing exemption as “extraordinarily generous”.
The Institute for Fiscal Studies called on the government to consider withdrawing a longstanding exemption that allows three-quarters of all contributions to pensions – those made by employers – to escape national insurance contributions (NICs) altogether.
“It is hard to justify the extraordinarily generous NICs treatment of employer pension contributions. Making employer pension contributions subject to employer NICs could raise an estimated £10.8bn a year,” it said in its ‘green budget’, the independent think-tank’s annual appraisal of the economy.
Employer pension contributions are the only substantial form of employee pay that escape NICs altogether, while pension income is not subject to NICs either.
The IFS said an alternative approach, which might be preferable on the grounds of intergenerational ‘fairness’, would be to start charging national contributions when pensions are paid out, which would raise an estimated £350m for every percentage point of tax.
It said: “One could argue that such a change could help to spread the government’s fiscal consolidation plan more evenly across the generations since the tax and benefit reforms announced to date have, on average, reduced the incomes of pensioners by less than those of working-age individuals.”
It also urged the government to consider restrictions on the ability to withdraw a quarter of the accumulated pension balance free of tax.
It said: “It is also hard to see why people with very large pension pots should be able to draw a lump sum of as much as £312,500 tax-free. The tax-free lump sum could be subject to a much tighter overall limit or the implied subsidy could be used more effectively.”
There were strong arguments against further restrictions on income tax relief, it said. “There is a myth that further restricting income tax relief on contributions to private pensions would be an equitable and largely harmless way of raising substantial sums of money.
“It would not be. It would impose a degree of double taxation on pension saving. It would also further disadvantage young savers relative to current pensioners, and would add more complexity for those in defined benefit pension schemes.”
The tax system’s treatment of pensions has become less generous for high earners, as a result of a reduction in the annual allowance, which limits the annual contributions that receive tax relief.
This is currently set at £50,000, but is due to fall to £40,000 from 2014-15, and is significantly lower than the £255,000 annual limit that was in place when the current government took office in 2010-11.
The IFS estimate of the net cost to the exchequer of the relief from income tax and national insurance contributions was less than half the official estimate of £38.3bn, as a result of behavioural changes. In 2012, about £70bn was contributed to funded private pensions, which had a total fund value in 2011 of more than £2tn.
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