Tax rules on pensions in line for a shake up

Chancellor George Osborne could change tax on pensions
Chancellor George Osborne could change tax on pensions

It is possible that savers will be asked to give up billions of pounds of tax relief that they have received if the government introduces new rules.

This is the prediction of Steve Webb who was recently Pension Minister in the coalition government.

The Treasury is considering rewriting the tax rules on pensions which currently ensure savers are charged only when they withdraw the cash after age 55.

In the future it is possible pensions could become very similar to ISAs, so in effect taxed upfront as no tax relief is granted, but on the plus side with no tax to pay on withdrawal, and a bonus added at retirement to reward long term investment.

If the government reform pensions in the way mentioned above, and deny relief on pensions, they will in effect bring in tax that would have been denied to them for decades.

This government is desperate for cash to cut the deficit and these actions could prove to be a great windfall for them. It is possible the chancellor George Osborne could go a step further and offer pensioners who have been paying into pensions for decades the opportunity to also have access to the fund at retirement tax free in return for a one off hit on your pension fund.

It may be that in the future there will still be a pension scheme which gives tax relief at source, but Steve Webb thinks it will be on a much smaller scale than our current scheme, with a flat rate of tax relief of 33 per cent and with a likelihood of 25 per cent tax free lump sum.

A lot of the thoughts aired above stem from a green paper Strengthening the Incentive to Save, which was a consultation paper published alongside the budget in the summer.

We are now going through a consultation period and very soon we will find out if the predictions are correct. If they are this could further complicate pensions as people having recently been given new pension freedoms could be grappling with other calculations. The dilemma would be whether they should pay tax on their pension income in the traditional sense at retirement, or pay a one off tax at retirement to allow access to the funds tax free.

These decisions will depend on things such as health at retirement, tax rates and personal preferences, with some of these calculations further complicating what was supposed to be simpler pensions.

I suppose the bottom line for the Exchequer is to save money by denying tax relief on one hand, and then perhaps taking in more tax by taxing traditional pension funds when they come to be drawn, on a one off basis.

I think the Chancellor has already found that pension freedom has been a money spinner for the government and now he is looking to build on this revenue. I believe he has found out people will often opt for short term gain and pay more tax rather than take a longer view and be more tax efficient.

So although these potential changes will be marketed as an encouragement to save, it is more likely the reality will mean that saving will be less rewarding.