Government plans to eventually scrap National Insurance (NI) could have huge implications for those claiming state pension and people paying income tax.
Chancellor Jeremy Hunt recently told Parliament there was a “long-term ambition” to scrap the tax.
Director of Pensions at Aegon, Steven Cameron, said of the proposal: “The consequences of abolishing National Insurance could dramatically change the pension landscape – for state, private and workplace pensions.
“While this clearly won’t and can’t happen overnight, the potential consequences need to be thought through in all their detail.
“While such a radical change may be seen as a simplification, the devil will be in the detail with many questions to answer.
“One key unknown is whether the ambition relates to employer NI as well as employee and self-employed NI contributions. And what would the consequences be for income tax rates.”
He said there are four key questions about how scrapping NI would take place and how it would affect pensions.
The first is how the state pension would be funded given current Government guidance speaks of an ‘NI fund’ that goes towards the state pension.
Mr Cameron said: “The Government still reports on the ‘NI fund’, showing NI contributions received against state pension and other payments made year on year.
“So even if NI contributions are set separately from increases in the state pension, we need longer term clarity from whoever is in power on where the money for state pensions will come from.”
His second concern was if income tax were increased after NI is scrapped, this could lead to generational unfairness.
He explained: “If NI were phased out, it’s likely that income tax rates would have to rise. Individuals currently receive tax relief on their pension contributions at their highest marginal rate, and pay income tax on income from their pension.
“So a ‘levelled up’ income tax rate would grant more relief on contributions but tax income from pensions by more. From a pensions perspective this could be ‘fair’ for someone starting their pensions savings.
“But it could be deeply unfair for those who are approaching or in retirement who could end up paying a higher rate of tax on their pension income than they’d received in tax relief on contributions.
“While those of working age may benefit from the scrapping of NI, those above state pension age wouldn’t as they’re already exempt from paying NI.”
His third query was what would replace the current NI contributions towards a person’s state pension. A person typically needs 35 years of contributions to get the full new state pension, of £203.85 a week.
Mr Cameron warned: “Currently entitlement to a state pension is based on years of NI contributions or credits such as when caring for children.
“Scrapping NI would require a new qualifying test – perhaps based on the number of years of paying income tax with credits for carers.”
His final concern was that pensions salary sacrifice arrangements would also need to be changed were NI to be scrapped.
Mr Cameron said: “Under salary sacrifice, the employee agrees with their employer to reduce their pay in exchange for a higher employer pension contribution, saving both income tax and also both employer and employee NI.
“The attractiveness of this will diminish if employee and potentially employer NI were scrapped.”
For the latest personal finance news, follow us on Twitter at @ExpressMoney_.
