Proposal for 30% tax relief rate on pensions criticised

Mon, Nov 23, 2009, 00:00

A REPORT commissioned by Irish Life has criticised a proposal to introduce a single rate of tax relief of 30 per cent on pension contributions.

The report by economist Moore McDowell found such a change would reduce the incentive for anyone earning more than €35,000 to make pension contributions.

Mr McDowell’s report is also critical of plans to reduce the taxfree lump sum. It has been proposed that the tax-free lump sum should be capped at about €200,000.

Mr McDowell asserts that, contrary to common belief, the current tax reliefs encourage middle income earners – those earning €45,000 to €75,000 a year – to save for their pension much more than higher income earners.

“The proposed change to a flat 30 per cent rate means that anyone [earning] over €35,000 will face a reduced incentive to make pension contributions,” Mr McDowell states. “The incentive declines more or less uniformly and disappears at about €130,000, and thereafter is actually negative: you are worse off if you subscribe to a pension than if you do not.”

Mr McDowell argues that criticisms of the current system stem from a misunderstanding of the way in which the tax treatment of pensions works in practice.

“A myth has grown which suggests that tax reliefs on pensions are net benefits to the taxpayer,” he stated.

“They conveniently ignore the fact that pension funds are taxed at the point of drawdown not at the point of contribution but the net effect for the exchequer and for the taxpayer are broadly neutral under the current system.

“However, under the reforms proposed, middle-income earners will be disadvantaged by paying the marginal rate of tax on drawdown but enjoying less relief at the point of contribution.”

The economist, who himself is retired, said the proposed change to a flat 30 per cent rate of relief would mean charging 11 per cent income tax on contributions in the case of those paying the higher rate of tax.

A commitment to revising the tax treatment of pension contributions was included in the revised programme for government.

The Government has agreed to introduce a single rate of relief on contributions of 30 per cent.

This was mooted in the Green Paper of 2007 on pensions and in the report of the Commission on Taxation in its report published in September, 2009.

Two reasons have been put forward for the move to a single rate. The first is that the current system means that those on the higher rate of tax earn a bigger tax break than those on the lower rate. The second is that the exchequer can no longer afford to forego an estimated €2.9 billion in tax revenues.

Mr McDowell was commissioned by Irish Life, Ireland’s biggest pensions provider, to study proposed reforms in the context of debate in Ireland about tax reliefs.

Commenting on the report, Irish Life chief executive Gerry Hassett said: “Clearly the Government is facing extremely difficult decisions in the coming budget, but pensions are a long-term issue that has significant consequences for our society.”