Analysis – Tax fears on pension reform.

With all eyes on the chancellor Gordon Brown to lower the duty on petrol and hand pensioners a significant increase on their allowance in the recent pre-Budget announcement – it almost went unnoticed that the pensions system is to undergo its most radical reform ever.

As Gordon Brown increased the basic pension by £5 and lowered and promised to freeze the duty on environmentally-friendly fuel, he also revealed brief plans to introduce Pensioner Tax Credit from 2003.

Social security secretary Alastair Darling followed up the announcement by unveiling the details of the DSS consultation document under the banner ‘radical pension reform’.

Although no decisions have been finalised – the system is under consultation until February – it is clear the government is looking to introduce a working families tax credit-style system in which the pension is offered as a credit but is tapered away as pensioners income increases.

The new system – expected to cost #2bn to implement – will combine the minimum income guarantee (MIG), which is already in place and boosts the pensions of those with a low income to a set minimum level – with the new tax credit (PTC).

PTC will allow pensioners whose income does not exceed the MIG to claim 60p in every £1 of income they earn over the state retirement pension limit. The idea is to reward pensioners who have accrued some form of savings from their working lives and those who earn extra money through part-time work.

‘For the first time ever the pension credit will make sure savings will be rewarded,’ says Darling. ‘There is a fundamental fault in the system we inherited. A pensioner with #20 of occupational pension on top of their state pension can find themselves just a pound or two better off than someone who saved nothing. That’s unfair, unjust and it’s going to stop,’ he adds.

When it begins in 2003, the credit will reward all those with weekly incomes up to £135 for single pensioner, or £200 for couples. The credit will guarantee a minimum income, which by 2003 will be at least £100 or £154 for couples. On top of that for every pound saved, pensioners will receive an additional cash credit. This could mean extra cash between £1 and £23 a week on top of the basic state pension depending on savings and other income.

The government proposes to get rid of the weekly means test and instead the credit will be based on an income assessment that is more like the tax system.

But there is no getting away from the fact that some pensioners, estimated to be as many as 60%, will be taxed at a rate of 40% – the same as highly paid executives – under the credit scheme.

Although it is better than the 100% rate endured by up to one in five pensioners at the moment, some experts believe the rate is still too high.

Maurice Fitzpatrick, head of economics at Chantrey Vellacott, says: ‘This revelation (40% tax) may put pressure on the Treasury to limit the effective marginal tax rate being paid by the 60% of pensioners to say 25%. This could be achieved by increasing the supplement paid on other income up to the MIG limit from 60% to 75% and by reducing the taper (by which PTC is restricted once income exceeds the MIG limit) from 40% to 25%.’

Anne Redston, Ernst & Young tax partner, adds: ‘The £2bn the government is spending on redeveloping the pensions system could be used to do what it seems unwilling to do – bump up current payments to pensioners and tax the better off. It would appear the new system is complicated and over-targeted. Surely it would make sense to simplify the system and reduce administration costs. The tax system is becoming too difficult to understand and now it seems pensions are going the same way. It is not necessary.’

The government is understood to be committed to ensuring the 60p in the #1 that pensioners will receive from 2003, will not be taxed at all. It would seem that because the government will be introducing a benefit to pensioners – to then tax that benefit would surely be a political blunder.

The move towards the credit follow the government’s promise to develop the pension system when it came to power.

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