Rumours that the chancellor will look to reduce higher rate tax relief on pensions, to help make cost savings in a post Covid environment, have surfaced again.
There has been speculation that Rishi Sunak is currently attracted to the idea of reforming pension tax relief so all pension savers receive a flat rate of 25 per cent, regardless of the marginal rate of income tax they pay.
While this may fit with the government’s stated plans of ‘levelling up’ and potential deliver cost savings for the Treasury, such plans have been floated before and have failed to materialise.
Speaking at a recent Corporate Adviser event former pensions minister Steve Webb, now a consultant at LCP pointed out that the government is unlikely to have the ‘bandwidth’ to introduce such plans, particularly with the civil service focused on the coronavirus pandemic and Brexit.
Such widespread reform would also hit the finances of DB schemes which has hampered plans to reform tax relief in the past.
Aegon pension director Steven Cameron say such a move would benefit basic rate taxpayers.
Aegon estimates that under a 25 per cent flat rate pension tax, a 22-year old on average pay of £27,000 paying 4 per cent into a DC pension could be £21,000 better off by state pension age.
In contrast higher rate taxpayers would lose out, with a 35-year old earning £60,000 paying the same 4 per cent into a DC pot being £85,000 worse off by retirement. Aegon say this individual would need to contribute an extra £50 per month initially to maintain current retirement aspirations.
Cameron says: “The Chancellor is rumoured to be considering changing the system so that rather than pensions tax relief varying with your income tax rate, everyone would receive a flat rate relief of 25 per cent.
“This is seen by many as a fairer way of sharing this Government incentive across people of all earnings bands but would also likely produce a cost saving for the Treasury. It would be good news for basic rate taxpayers who’d receive a more generous bonus but would create a big dent in the future pension pots of higher and additional rate taxpayers unless they increased their contributions.”
However he pointed out that pensions would still be tax efficient vehicles for these higher earners.
“As well as tax incentives on contributions, individuals can take one quarter of their pension proceeds tax free, with the balance being taxed as income at the rate they pay in retirement.
“This means pensions are already regarded as the most tax efficient means of saving for retirement and the rumoured changes would make pensions an even better deal for those paying basic rate income tax.
“Most individuals paying higher rate tax when working pay basic rate income tax once they’ve retired. For them, pensions would still be very tax efficient under a flat rate 25 per cent tax relief system.”
However he adds: “The group for whom it’s less clear are those who might be higher rate taxpayers in retirement, who might need to weigh up the pros and cons. But like all employees who contribute to a workplace pension, they would also receive valuable employer contributions offering an additional attraction.”
He urged caution though prior to any wide-ranging changes. “Before implementing a move to a flat rate of pensions tax relief, more thinking is needed on how this would work for those contributing to a defined benefit or final salary scheme.
“Here, the pension benefits they receive are based on their final or career average salary and not on the amount their contributions grow to after tax relief and investment growth. For consistency with those contributing to defined contribution schemes, higher and additional rate taxpayers in defined benefit schemes might see their and their employer’s contributions taxed as a benefit in kind, increasing their tax bills.”
Previous changes to annual and lifetime allowances, resulted in many consultants and doctors received unexpected tax charges, before Sunak made changes in the last Budget, effectively making these allowance more generous, increasing costs to the Treasury.
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