A national think tank has proposed a new blueprint for taxing pensions, which might appeal to a future government.
Tax and pensions. This combination is enough to give most people a reason for their eyes to glaze over. However, the duo is one with a price tag of nearly £55bn in terms of relief from income tax and National Insurance contributions (NICs).
The last major overhaul to the tax and pensions framework took effect in 2006. At the time, it was labelled “simplification”. However, 17 years of tweaks – many designed to reduce those reliefs – have resulted in what has been described as “complification”. As seems to be the case with many of the UK tax regimes, a design that conceived as a sleek racehorse has ended up as a camel in need of major surgery.
The Institute for Fiscal Studies (IFS) is the latest organisation to put forward proposals to bring some rationality back into the world of tax and pensions. Among its proposals are:
Tax-free cash: As a broad rule you can draw 25% of your pension pot as a lump sum, free of tax, provided your pot does not exceed £1,073,100 – so a maximum tax-free sum of £268,275. The IFS thinks this represents too much of a tax subsidy to higher earners and proposes that the figure should fall to £100,000.
NICs: If your employer contributes to your pension, neither you nor your employer pays NICs on the contribution. However, if you make a pension contribution personally from your pay, then your employer pays NICs on that pay (at up to 13.8%) and so do you (at up to 12.0%). The IFS suggests that the NICs relief on employer’s contributions should be replaced by a subsidy, the level of which does not have to match the employer NICs rate. For employees (and the self-employed), the IFS goes in the opposite direction and says full NICs relief should be given.
Pensions in payment: There is a sting in the tail that comes with NICs relief for personal contributions – the IFS wants pension payments to gradually become subject to NICs, just as earnings are now.
It would be a brave politician that put some of the IFS’s proposals in their 2024 manifesto, but that does not mean they might not appear sometime after the election. In the meantime, maximising your pension contributions in the most tax-efficient way remains a priority.
The value of your investment and any income from it can go down as well as up and you may not get back the full amount you invested.
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