Self-invested personal pensions (SIPPs) are a kind of personal pension which offer a broader scope for choosing which assets to invest in than typical personal pension schemes do. These assets include quoted and unlisted stocks and shares, collective investments, investment trusts, and property and land investment bonds. Income can be drawn from a SIPP once the holder reaches the age of 55, whether or not they are in work. Income paid out from a SIPP is subject to Income Tax but not National Insurance contributions, like other pensions. Up to one-quarter of the total pension can be withdrawn as a lump sum, tax-free [1]. In short, SIPPs are a personal pension where the holder can direct the investments made, rather than having that managed for them [2].

 

All personal pension contributions, including SIPPs, receive Income Tax relief up to an annual limit of £40,000 or 100% of earnings, whichever is lower; and a lifetime limit of £1.073 million. Any contributions within this limit are automatically topped up by 20% to relieve Basic Rate tax payments and Higher Rate payers can also claim back a further 20% [3, 4]. Effectively, the government is refunding Income Tax for people who are willing and able to set aside a portion of their salary for later life.

 

SIPPs investors can potentially use them as a lucrative tax-free investment vehicle: they make tax-free contributions and take a quarter of the resultant pot out tax-free; income drawn from the pension would be taxed, but if their investments are successful the pot will have grown substantially by then anyway meaning they still gain. Any investments within a SIPP are able to grow free from paying tax on capital gains or dividends, similar to how investments within an ISA can grow tax-free [5].

 

Similar tax benefits are available to all kinds of personal pensions, though depending on the management of investments they may not grow as well as SIPPs (of course, they could grow better than a poorly managed SIPP!)

 

Why do we value idleness over work?

 

Given all the other tax advantages that savings and investments receive: substantial tax-free allowances for capital gains and dividends, lower rates of tax when those are charged, and other tax-free investment opportunities in the form of ISAs, pension tax reliefs are another element of a hugely favourable tax landscape for those able to afford to make substantial savings and investments. This is a deeply regressive tax relief – the well-off can make full use of it ,while for poorer households living paycheque to paycheque putting aside a significant amount of their income for retirement is an impractical luxury.

 

The cost of pension tax relief – in terms of tax revenues foregone – amounts to £39.9 billion as of 2019-20, composed roughly equally from reliefs on Income Tax and on employer National Insurance contributions. This relief has been increasing in value, up from £31.7 billion in 2014-15 [6].

 

The distribution of tax relief is far from equal. In 2015-16, the top 1% of income tax payers with incomes over £150,000/year accounted for 15% of pension contributions receiving tax relief; the top 11% earning over £50,000/year accounted for 52% of contributions attracting relief. On the other hand, the 40% of taxpayers earning less than £20,000/year accounted for 7% of such contributions. About 65% of pension tax relief was expected to be spend on higher and additional rate taxpayers in 2018, who only account for 17% of taxpayers [7]. In other words, pension tax relief is an expensive tax break that mostly benefits people on higher incomes.

 

Private pensions wealth makes up the largest portion of aggregate household wealth in the UK - £6.1 trillion or about 42% of the total – and has accounted for about half of the growth of wealth in recent years [8]. This means that tax reliefs are also benefiting a vast and growing accumulation of wealth.

 

Given the cost of this tax relief you would hope that it is effective on its own terms – i.e., it actually encourages people to save for retirement. There is, however, little to no evidence that tax incentives for saving actually work with many people, especially those on low incomes, still thought to be saving too little for their retirements. Intuitively, tax reliefs on contributions do not solve the fundamental issue for people on low incomes and with little to no wealth, which is that they simply do not have enough money to be able to put aside a substantial amount in savings without severely reducing their current standard of living. Tax incentives for savings might ultimately just benefit those who are already well-off enough to be able to make substantial savings and who were likely to save anyway, because the rationale of making profitable benefits and putting aside money for retirement would still apply even if there were no tax advantage to be gained [9].

 

Tax work a bit less and stop subsidising wealthy retirement.

 

Tax relief on personal pensions is largely just a reward for those who would be willing and able to save for their retirements anyway. Wealthy households do not need any encouragement to engage in prudent financial planning and it is absurd for the government to dedicate so much fiscal firepower towards rewarding them for doing so. SIPPs are a particularly egregious example, those with the time and inclination to personally direct their investments are taking personal responsibility for their retirement fund and likely have a substantial amount of savings to play with to justify taking that risk. The state pension already exists as a safety net and to provide a basic level of income in retirement, the state does not need to provide further support to those building up extra income.

 

Cutting pension tax reliefs would give the government the fiscal space to instead reduce taxes on work, especially where high effective marginal rates exist. Doing so would give people more disposable income with which to save in the first place and so would not obviously result in less saving, while also producing a fairer balance of the tax burden between those who work and those who live off the assets they own.

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1https://www.pensionsadvisoryservice.org.uk/about-pensions/pensions-basics/contract-based-schemes/self-invested-personal-pensions-sipp

2https://www.moneyadviceservice.org.uk/en/articles/self-invested-personal-pensions

3https://www.gov.uk/tax-on-your-private-pension

4https://www.pensionsadvisoryservice.org.uk/about-pensions/saving-into-a-pension/pensions-and-tax/tax-relief-and-contributions

5https://www.youinvest.co.uk/sipp/tax-benefits-sipp

6https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/837766/191009_Bulletin_FINAL.pdf

7https://researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-7505

8https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/totalwealthingreatbritain/april2016tomarch2018#trends-in-total-wealth-inequality-in-great-britain

9 https://www.pensionspolicyinstitute.org.uk/media/2278/20041011-ppi-tax-incentives-for-pension-saving-ace.pdf