Written by Jon Dean on Wednesday 4 May 2016
On 6th April 2006, or “A-Day” as we know it, pension taxation was to undergo its biggest overhaul in 26 years. Before this, the industry was burdened with eight different tax regimes; four different occupational scheme regimes (remember those old-code, new code, 1987 and 1989 rules?), separate rule sets for Personal Pensions and Retirement Annuity Contracts and two more for unapproved schemes. The government of the day recognised that this was a complete dog’s breakfast and, in 2002, instigated the Sandler Review which resulted in so-called “Pension Simplification”.
The Sandler recommendations were to reduce the number of tax regimes to as few as possible, and that the tax system “should seek to limit either the contributions to pensions or the benefits paid out, but not both”. The 2004 Budget confirmed there would be one annual contribution allowance of £215,000 and one lifetime allowance (LTA) of £1.5m, both indexed so that only the top 1% of earners would ever pay the 55% excess benefit charge. This single rule set would replace all eight previous regimes. I remember at the time this being talked about as the last big tax reform for a generation.
Nowadays, once-in-a-lifetime reforms seem to happen with increasing regularity. Lifetimes ain’t what they used to be. Between April 2010 and April 2016, the LTA fell 3 times from a peak of £1.8m to £1m. With each cut, at least one new form of protection was introduced. Starting with Primary and Enhanced Protection, we now have Fixed Protection, Fixed Protection 2014, Individual Protection 2014 and two new Fixed and Individual Protection variants from 2016. Generally, at least two protections can apply to the same member. Curiously echoing the eight old tax regimes, we now have one tax regime and seven different exception cases. The Treasury estimates that LTA now impacts around 4% of pension savers.
On top of the LTA shenanigans, the annual allowance which peaked in 2010 at £255,000 has also been cut to £40,000, with a new taper for high earners and a £10,000 limit after accessing pension freedoms. Ironically, simplification has over time made things as complex as they were a decade ago.
Ahead of this year’s Budget we were all waiting with bated breath for the Chancellor to announce a major overhaul of pension tax treatment, widely expected to be a change to flat rate relief. A rate of 25% would have saved the Treasury £6bn a year according to the Pensions Policy Institute, and would also be an easy sell to the public (save £3, get £1 free from HM Treasury). Instead, George Osborne announced no changes to pension taxation, but introduced the new Lifetime ISA (LISA) available to under-40s, with 20% government top-up capped at £1000 available for account holders under 50. This looks remarkably like the pension ISA touted by Michael Johnson of the Centre for Policy Studies.
The last 10 years of UK pension policy have stretched the Sandler recommendations to breaking point. We are effectively back to square one with the number of tax regimes, and the continued reductions of LTA and Annual Allowance are, in practice, limiting both contributions and benefits. But the direction of travel in pension policy suggests that major reform is not far away. How soon before the Government enacts the ultimate pension simplification: switch off pension relief at source and force firms to auto-enrol workers into LISAs? Wouldn’t that make pensions as we know them obsolete?