Simplification is the key - Centre for Policy Studies

TEE would be hugely attractive to pensioners as it provides them with tax-free income,
although some people would remain sceptical, concerned that the state may
subsequently be tempted to revert back to a “final T”.
Alternative Two: 20% upfront relief for everyone?
If upfront tax relief were limited to 20% (i.e. E 20% ET), irrespective of the saver’s marginal
rate of tax, the Treasury would save roughly £7 billion per year. 121 This saving opens up
the intriguing prospect of reintroducing the rebate on the 10p tax credit, so that “middle
E” becomes genuine (again). A crude calculation of the cost of restoring the rebate is to
assume income (interest and dividends) of 2% on all of the UK’s pension fund assets
(£2,000 billion, say): £40 billion. A 10p tax on this comes to £4 billion. If the rebate were
restored, the Treasury would be exposed (i.e. a lost income opportunity) to future rises in
fund income (likely given how low interest rates and dividends are today).
However, limiting tax relief to 20% would not provide a pension savings incentive to those
who expect to pay 40% income tax in retirement (who are probably paying 40% or 50%
income tax whilst working). This could be addressed by limiting income tax to 20% for all
pensioners (i.e. E 20% ET 20% ); had this tax structure been in place in 2008-09, the Treasury
would have saved £5.6 billion in tax relief costs (compared to EET; see Table 13).
If income in retirement were to become tax-exempt (i.e. E 20% EE), there would be a
relatively small additional cost to the Treasury compared to today (£2.5 billion); not very
palatable in current circumstances.
Alternative Three: consider ETE?
An ETE framework preserves the upfront incentive and tax-free post-SPA income. Within
the context of today’s tax treatment of pension savings (EET), the cost would not be large
because introducing “middle T” would save £6.7 billion and making pensions tax free
would cost £9.5 billion. The cost of exempting capital gains is currently ignored, and
should remain so because of the practical difficulties of taxing unrealised capital gains
within a fund. ETE does diminish the benefit to the saver of the power of compounding of
accruals, but given that most savers do not appreciate the value that this creates, they
may welcome ETE rather than EET (some capital gains annual allowance would have to
be retained).
121
Upfront relief (excluding NICs’ £8.2 billion) was £21.7 billion in 2008-09, some 60% of which went to HRT
payers. 60% of £21.7 = £13 billion. Add £0.9 billion for SIPP under-reporting = £13.9 billion. Cutting this relief
in half (from 40% to 20%) saves about £7 billion.
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