Why pension tax reliefs may not last forever

Governments have repeatedly reshaped pension policy to manage costs – and with mounting fiscal pressure, today’s tax reliefs may prove more temporary than many investors expect. Our special contributor and Daily Telegraph investment columnist David Stevenson explores the topic in greater depth.

Pension tax reliefs are a relatively recent innovation in the history of finance and investment, although governments of all colours have spent the last few decades trying to rein in the pension generosity. And to make matters even more uncertain, there are plenty of think tanks and very smart people who would like to do away with most of the reliefs altogether. Their animus? The sheer cost of these reliefs.

So, let’s back up and have a quick dash through the history of pensions in the UK. As an aside, the history of Individual Savings Accounts (ISAs) is even more abbreviated, and if you think that pension tax relief might be curtailed, then there’s no reason why the same can’t be true for ISAs.

A history of progress and retreats in pension policy

Pension tax relief in the UK is a relatively modern innovation, introduced in 1921 to sit alongside the many occupational pensions that had existed since the late 17^th century. The Victorian era turbocharged these workplace pensions, but to make the system more equitable and national in scope, the Finance Act of 1921 introduced tax relief for pension contributions and investment income, subject to conditions – most notably that the assets must be held in a trust separate from the relevant company. This legislation’s greatest legacy is that it established the principle of contributions being exempt from tax; investment growth is also exempt, but income tax is charged on the way out when the pension is paid.

But by 1947, another Finance Act had begun to curb those privileges, with limits on lump sums and capping pensions in the public sector. In 1978, a Labour government introduced the State Earnings Related Pension Scheme (SERPS), which was basically a pay-as-you-go, get-more-out scheme. By the 1980s, more and more limits were being placed on pensions, including yet more caps on the lump sum you could take. By the way, SERPS was also abolished a few decades later.

Then came 1997 and Gordon Brown, then UK Chancellor of the Exchequer under Tony Blair, who decided to abolish tax relief on dividends received by pension funds on their investments. This simple cut, bitterly resisted, has produced tens of billions in extra revenues for the Exchequer. But the then Labour government tried to make amends by introducing what was called the A-Day reforms in 2006, which ‘simplified’ the pensions regime into just occupational and personal pensions.

But what the government gave with one hand – simplification – it took away with the other by introducing an annual allowance as well as a Lifetime Allowance (LTA). And guess what’s happened to the Annual Allowance – yes, it’s been whittled back. The Annual Allowance was cut from £255,000 in 2010 to £50,000 in 2011/12 and £40,000 in 2014, although it was increased back to £60,000 in April 2023. As for the Lifetime Allowance whittling, it peaked at £1.8 million in 2011/12 before being cut several times to £1.073 million. Note that the LTA charge was removed in 2023 and the allowance was formally abolished in April 2024.

What’s the big takeaway? Simple: don’t rely on governments to stick to their own rules, especially if the Treasury thinks it can squeeze more money out of them. Another way of putting it is that pension policy and the reliefs that accompany it are largely transitory and liable to sudden, sometimes dramatic change.

The think tank(ers) are gunning for tax relief

This brings us to the present day and the various think tanks that try to influence government policy. It won’t surprise you to know that pensions are an especially vexed subject. I’ll use the example of pensions expert Michael Johnson, who is widely respected and has consistently pushed for drastic reform of the pension regime – though his views are very widely shared, and other policy experts have made the same arguments.

Back in 2013, for the right-wing, conservative think tank the Centre for Policy Studies (CPS), he penned what I thought was an incisive paper calling for the government to scrap higher-rate tax relief altogether. The core driver was the simplification of the regime for Johnson, but there was also the matter of cost. An explainer back in 2013, around the paper, argued that the reliefs at the time were “hugely expensive. They comprise: tax relief on contributions (cost: £26.1 billion in 2010-11), a tax-exempt 25% lump sum at retirement (£2.5 bn), NICs relief on employer contributions (£13 bn) and tax relief on investment income (£6.8 bn). Over the last decade, relief on income tax and NICs has totalled £358.6 billion, (excluding tax foregone on the tax-exempt 25% lump sum).”

Flash forward more than ten years, and Johnson wrote another paper for a more centrist think tank, the Social Market Foundation, making a very similar case. Its headline was, you guessed it, “Scrap all pensions tax relief and NICs rebates, replacing them with ‘savings bonuses’, top pensions expert says”.

In his latest paper, he argued that: “With public finances as constrained as they are, Johnson considers both tax-based incentives to be an ‘ineffective use of scarce Treasury resources’, evidenced by the UK having one of the lowest household savings ratios in the developed world.

Johnson suggests that bonuses should be paid on individual and employer (post-tax) contributions, capped at £2,500 per year. A bonus rate of 25% would apply to all savings up to £10,000, more than adequate for 95% of people.”

Personally, I think Johnson has some excellent ideas, but the cynic might say the world is full of think tanks and clever folks like Johnson, and nothing has changed… yet. But Johnson is widely respected within the Treasury, and it has a direct incentive to listen to him. Pension tax reliefs are expensive, and the government – this one and frankly any future one – will need to save money, somehow.

Tax reliefs cost money… that Treasuries worldwide don’t have

Johnson currently puts the annual cost of these reliefs at £44 billion in Income Tax relief on pension contributions, which is disproportionately borne by the wealthy. An additional £28 billion was paid out in NICs rebates on employer contributions; largely invisible to employees (and therefore unappreciated), and unavailable to the self-employed, as NICs rebates benefit company shareholders primarily.

To put some perspective on those big numbers, if the UK government is to keep to its commitment to increase defence spending to 3% and then maybe lift it to 3.5% of GDP, the savings Johnson has identified would cover the full cost of this security upgrade. Sure, there would be many unhappy pensioners and pension companies, but we might all survive and win a future war. Not much of a contest in policy terms there, is it?

Now, as I just mentioned, plenty of people and industry folk would kick up a stink if there were drastic changes, as they would if the Triple Lock on state pensions were lifted, which I rate as an absolute certainty within the next five years. But governments, in the UK and throughout the developed world, have made drastic changes to their pensions many, many times before.

Take the case of the 1995 Pensions Act, which increased the state pension age for women from 60 to 65 to equalise it with men’s, with the change to be phased in over 10 years from 2010. This transition was later sped up by the 2011 Pensions Act.

Both the 1995 and 2011 changes affected 3.6 million women who discovered they would have to wait up to six years longer for their state pension, potentially affecting their retirement plans. The WASPI (Women Against State Pension Inequality) groups have been fighting this battle for compensation ever since, to zero net result.

Looking further afield to Poland, in 2013 the government there seized 153 billion zloty ($50.4 billion) in Polish Treasury bonds from 13 private pension funds – an amount equal to slightly more than half of their investment portfolios. The driving motive was a constitutional debt constraint, not pension adequacy. Poland was in a bit of a deficit bind under EU rules, so politicians came up with a creative way to reduce debt levels.

Or there’s Hungary in 2010, which nationalised $14 billion of private pension assets to reduce the budget deficit and public debt. The state threatened to bar anyone from the state pension system if they did not transfer their private individual accounts. This effectively compelled compliance.

Other European governments conducted similar raids in the same period: Portugal confiscated the pension assets of its largest banks (around three-quarters of private pensions) in 2011, while Ireland in 2009 earmarked €4 billion from its National Pension Reserve Fund – established explicitly for long-term pension provision – for rescuing banks, with the remaining €2.5 billion seized in 2010 for the wider country bailout. France separately took €33 billion from its National Reserve Pension Fund to reduce near-term deficits, using money set aside for 2020–2040.

So, what’s my message?

The UK government, through the Debt Management Office, is currently paying the highest rate of interest on long-term borrowing compared to all the G7 countries. These yields are punitive, and they could even become even more punitive if the government has to borrow yet more money to pay for the NHS/the defence upgrade/public sector pensions (fill in your favourite state spending item or bugbear).

The Treasury is constantly looking around for ways to either tax more, spend less or recover reliefs – or a combination of all at different times. I would cordially suggest that pensions sit somewhere at the top of that list (along with ISAs), and the evidence is clear that politicians have a long track record of cutting back reliefs and making the system less expensive for the Treasury but more expensive for you.

Personally, I give the chances of higher tax relief for pensions and the Triple Lock on the state pension (which guarantees annual increases by the highest of inflation, wage growth or 2.5%) staying in place beyond, say, 2030, less than 50%. I also think the pressure for a standard one-size-fits-all pension relief level – say, 25% – will become overwhelming on the basis of simplification logic alone. And I also think we’ve seen the first major cut to the ISA regime (the reduction of the Cash allowance), and more are likely to come.

So, my simple message is this: use the generous reliefs available to you now before you lose them. It may not happen this year, or even next, but my policy weather vane says trouble is coming and those reliefs and subsidies are not long for this increasingly precarious world.