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More changes to taxation of pensions?

Individuals and others that wish to contribute to the debate about the latest proposed changes to the taxation of pensions have until the end of this month to do so when the Government’s consultation on pensions’ tax relief closes.

Pensions have of course been subject to a number of changes over the last few years with increased flexibility over how they are accessed and the end to compulsory annuities being developments that have received a great deal of publicity. In the Summer Budget the Government announced that it also wished to review the current system of taxation of pensions. This was followed on the same day by the issue of a Green Paper on this subject to which responses are invited.

The Green Paper emphasises that the Government is viewing this subject in the context of increased longevity, and no doubt the £50 billion that, according to the Green Paper, tax relief on pensions cost the Exchequer in 2013/14 is a factor also. The Green Paper emphasises that the Government feels that the key features of any new system should be sustainability, transparency and personal responsibility for the pension investor.

Under the current system, pensions contributions receive tax relief both at basic and higher rates of tax, and the gains and income of pension funds are tax free, but pension payments to the individual after retirement are potentially liable to income tax, apart from the 25% tax free lump sum.

The growing cost of tax relief on pension contributions has caused the recent reductions in the annual allowance (the amount that an individual can save in a pension and receive tax benefits) to £40,000 per year and the proposed reduction in the lifetime allowance from £1.25 million to £1 million from April 2016.

The Green Paper puts forward for consideration a possible move to a system similar to the tax position of ISAs. This would mean that there would be no tax relief on pension contributions when they are made, the pension funds’ income and gains would still be tax-free and there would be no income tax payable on pension payments received by the individual after retirement. It has been pointed out that this could lead to a significant saving by the Treasury as most people pay tax at higher rates during their working life than after retirement. The benefit of not paying 20% income tax on a pension payment after retirement could be outweighed by the potential loss of 40% tax relief on the pension contributions when made.

Some commentators seem to think that an ISA style system is almost inevitable but more information will be available once the consultation closes and the Government publishes its “summary of responses” indicating how it intends to proceed.

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