This is what the IFS has to say about raising revenues by slashing the capacity of those with large pots to take pension tax-free cash. What do you think?
The 25% tax-free component should be targeted towards those with smaller pensions, not those with higher incomes
When withdrawn, 25% of a pension can be taken tax-free (up to a limit of 25% of £1,073,100, i.e. £268,275), with income tax payable on other withdrawals. This subsidy to pension saving has an estimated long-run annual cost of £5.5 billion, with 70% of the relief going to pensions accumulated by those in the top fifth of earners when making their contributions. This well-known part of the pensions landscape could have some justification if it encouraged saving on the part of those who would otherwise save too little. However, it is poorly targeted in two regards.
First, the 25% tax-free component subsidises further pension saving even for those who already have large pensions. While there is a case for encouraging people to save at least a certain amount for their retirement, it is hard to justify continuing to subsidise extra saving for individuals with pension wealth little short of £1,073,100.
The incentive should be removed from those with larger pensions. Reducing the amount that can be taken tax-free from £286,275 to £100,000, for example, would affect about one-in-five retirees (and almost half of those who had been employed in the public sector) but would mean about 40% of pension wealth lost the benefit of the tax-free component. Such a change would raise around £2 billion a year in the long run (40% of the long-run revenue yield from abolishing the tax-free component completely), with losses concentrated among the relatively wealthy.
Second, the 25% tax-free component provides a more generous subsidy for higher-rate taxpayers than for basic-rate taxpayers, and provides no subsidy at all for the part of pension income below the income tax personal allowance – that is, for those low-income pensioners whose pensions arguably most need boosting. A better alternative would give an equal top-up on all withdrawals from pensions. A top-up of 6.25% (before applying income tax), for example, would be equivalent to the 25% tax-free component for someone who is a basic-rate taxpayer in retirement. But such a change would mean a bigger subsidy than now for non-taxpaying pensioners and a reduction in the subsidy going to those paying the higher or additional rate of income tax in retirement. Overall, it would be a tax cut of around £1½ billion a year in the long run – although such a change could be implemented alongside a cap on the cumulative amount of pension income to which the top-up was applied, further reducing the subsidy for those with large pension pots and therefore the overall cost.
One complication with such a change is that it would (unless implemented over a generational time frame) involve some degree of retrospection: people could reasonably argue that they had saved on the understanding that they would be able to take 25% of their pension tax-free. A slower transition would temper that retrospection but would also need to be weighed against the ongoing costs of providing large tax subsidies for individuals with sizeable pension pots.
