Cutting pension contribution tax relief is not as straightforward as it’s painted.

19 October, 2010

Fr Sean Healy, the knows-enough-to-be-dangerous-but-not-enough-to-talk-sense spokesman for Conference of Religious of Ireland Social Justice Ireland, has claimed that €1.4bn could be saved by reducing the pension income tax relief to 20pc.  But as usual he has the numbers wrong.

Would employees be taxed (as a BIK – Benefit in Kind) on the value of company contributions to pension scheme on their behalf?  If not, then I can see that as being a major source of leakage which would depress the tax yield from the proposal.

But if private sector employees are to be taxed on employer contributions, then surely state employees should be taxed on the imputed value of the state’s contribution to their pensions?  Now that would be interesting.

In a paper presented to the recent Dublin Economic Workshop, a leading pensions expert said the only way to get savings of €1bn by cutting the pension tax relief to 20pc was to also tax the value of the contributions made to pensions by employers. This would hit public servants hardest, he said.  The value of an index-linked pension is massive.  I could see a public servant earning €50,000 having to pay an extra €4,000 or so in BIK.  Would that breach the Croke Park Agreement?

Fr Healy also fails to understand that employee pension contributions do not benefit from a permanent tax saving;  on the contrary, they are put into a fund and are later taxed when the employee retires and draws them down as a pension.  By and large, the tax is just deferred.

So if I only get 20% tax relief when I put the money into the scheme, but am taxed at up to 41% when I withdraw it, then why on earth would I continue to make such contributions?

The real impact of Healy’s proposal would be to make it even harder for the State to persuade private sector workers to fund an adequate pension for when they retire.  And ultimately such under-funded workers would fall back on the State’s coffers for assistance.

Another example of the law of unintended consequences.

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