Mark Wadsworth is a Chartered Tax Advisor. He blogs here.
The eternal fall back when people talk about pensions is that “We must encourage people to save” and give the matter little further thought apart from assuming that the only form of encouragement is tax breaks. It is, in fact, mathematically and logically impossible to improve people’s incomes in retirement by tweaking the tax system, and by and large it reduces it. A few salient facts (annual figures unless stated, figures for 2011-12 where available):
1. The total value of all the tax breaks for pensions saving are soaked up in fees and charges by the pensions industry
The total cost of income tax and National Insurance reliefs before netting off income tax withheld from pensions in payment is £51.9 billion (pdf) (total income tax withheld from pensions in payment is £8.4 billion) and the total value of fees and charges levied by the pensions is in the order of £50 billion. Thus all the tax breaks taken together do not increase the retirement incomes of pensions savers by one penny, and it is far cheaper to top-up the state pensions to the level of Iain Duncan Smith’s proposed Citizen Pension of around £150 per week.
2. Sixty per cent of the value of tax breaks for pensions saving accrue to higher rate taxpayers
In other words, if the value of the tax breaks were not siphoned off by the pensions industry, higher rate taxpayers would receive tax relief worth £30 billion. If the value of the relief were halved it would save £15 billion, more than enough to scrap the higher and additional rates of income tax. Using HMRC’s ready reckoner (pdf), this would only ‘cost’ £13.1 billion. In other words, higher and additional rate tax only have to be imposed to fund tax breaks for higher and additional rate taxpayers, the whole thing is a negative sum game. Please note, this would actually lead to regressive tax rates, because of National Insurance, so is not necessarily the best kind of tax reduction (see point 4).