The politicians intent on pillaging your pension

The Green party proposed an eye-catching policy for high earning London home­owners with large pension savings this week. It wants to seize their entire incomes.

Under a Green government, a doctor earning £95,000 a year, living in a £1.8m house, with a pension valued at £1.2m (enough for a retirement income of £45,000 a year), would pay income tax of perhaps £35,000 and a wealth tax(2 per cent of assets of £3m or more) of £60,000 a year. She would then be left with zero in post-tax income, although she might defer paying the wealth tax until she sold the house.

The Greens' wealth tax is an extreme, but they are not alone in regarding private pension savings as honeypots of taxable wealth. As the election nears, Labour and Conservatives are vying to reduce tax relief on pensions and slap levies on the highest earners' pension contributions. For anyone earning more than £150,000, private pensions are becoming a danger zone.

For most, that is a remote prospect. But many professionals in the private and public sectors are being struck by repeated, confusing changes to tax reliefs and annuity rules. As of "pensions freedom day" this month, retirees are no longer required to convert pension savings into annuities, but can draw the money as they wish, or even spend the whole sum at once.

Which 30-year-old would voluntarily start saving for a pension now, knowing that the rules are likely to change every year, and pensions tax reliefs will be ratcheted ever downward? The traditional bargain - that governments allow broad tax reliefs for savings provided that people used them to ensure a steady, taxable income in old age, is being broken apart.

"Pensions are finished. I don't think they have a future," says Michael Johnson, a research fellow at the Centre for Policy Studies. Even allowing for hyperbole, that is highly plausible. Near-sighted politics and fiscal desperation have made it tempting to plunder the £35bn in pension tax reliefs, and to undermine the ethical and financial framework behind the idea.

No politician admits that, of course. Instead, they justify the rapid decrease in the amount that people can save tax-free into pensions as being aimed at wealthy pensioners who can take care of themselves, and have gained from higher-rate tax relief. Time to assist the less privileged instead, they say.

There is some logic here. Higher rate taxpayers who shelter income in pension schemes gain more than basic rate taxpayers, both initially and as investment returns accumulate. The Pensions Policy Institute estimates that people in the 45 per cent income tax bracket at £150,000 a year gain 20 per cent of reliefs while making only 10 per cent of private pension contributions.

But there are two flaws in the logic. First, it makes no sense in generational terms. Current pensioners and people near pension age have already saved, or nearly saved, for their retirement benefits. The people who will be worst affected in coming decades are younger people who have not.

Second, neither of the main parties has promised to reform the tax system to balance benefits more evenly. The simplest way to do so would be to offer flat-rate tax relief of about 30 per cent, which John Ralfe, a pension policy consultant, describes as "more equitable and more efficient". That is backed by Steve Webb, the Liberal Democrat pensions minister, and others.

Moving relief from those on high incomes to other taxpayers does not raise money for the Treasury, it only shifts the benefits. Despite the rhetoric about a fairer system, both Conservatives and Labour actually want a less-generous system - one that raises taxes today at the cost of reducing them in a few decades time, when it will be another government's problem.

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Pensions are the softest of targets because few people understand them, and most were not listening as George Osborne, the chancellor, announced his cuts to lifetime and annual pension allowances. Both the main parties have tied their hands behind their backs in terms of raising headline tax rates, so they have a strong incentive to cut pension tax reliefs instead.

Mr Osborne's main contribution to weakening the foundations of private pensions has been to allow people to use savings as they wish in retirement, rather than having to buy annuities. That crowd-pleaser advances tax revenues; it also undermines the ethical basis for treating pensions differently from shorter-term savings, such as individual savings accounts (ISAs).

He has since matched Labour by pledging bizarre distortions in pension tax relief for those earning more than £150,000 a year, which the Institute for Fiscal Studies says risk "something like chaos". Anyone above that level who has been building a pension will have heavy incentives to call a halt, and invest in buy-to-let property or ISAs.

People on lower incomes, with less than £1m in a pension scheme (the level to which Mr Osborne cut the annual allowance in the March Budget), have so far escaped, but for how long? The direction of travel is clear, despite this government's countervailing effort to draw more employees into workplace pensions through automatic enrolment.

The next government will be under fiscal pressure, but it should be wary of plundering pension savings. The more people dependent on the state for their retirement, the greater the liability the UK faces. That may not matter much to today's politicians, but it will matter a great deal tomorrow.

The writer is the FT's chief business­ ­commentator

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