The cost of income tax relief on pension contributions has increased to £27bn in 2022/23 according to new government estimates.
This has increased from a little under £20bn five years ago. For the first time in 2021/22, the total cost of pension tax relief exceeded £50bn, according to new HM Revenue & Customs figures.
In 2021/22, income tax relief was projected to cost the exchequer £26.9bn, an increase of £7.1bn over the previous five years.
This tax year, Isas are anticipated to help save £4.3bn in income tax and capital gains tax. This is an increase of 5 per cent from £3.55bn a year ago.
Meanwhile, the cost of National Insurance Contributions (NICs) reduction in 2021/22 was £24.7bn, £8bn more than in 2017/18.
LCP partner Steve Webb says: “If the cost of pension tax relief is rising this should be a cause for celebration not a justification for cuts. The government has actively encouraged more than ten million people to start saving for a pension and has stepped up the mandatory level of pension contributions. All of this will increase the headline cost of pension tax relief. But this is a sign of the success of the policy.
“Likewise, if companies put more money into their Defined Benefit pension schemes to make sure pension promises to date are kept, this is to be welcomed even if it increases the cost of tax relief. The Government needs to decide if it wants more people to save in a pension or not. If it does, then constant tinkering and cuts to tax relief is not the way forward”
AJ Bell head of retirement policy Tom Selby says: “The cost of incentivising people to save for retirement is, on the face of it, eye-watering, with the ‘net’ annual bill – taking into account tax raked in from pension withdrawals – estimated to have surged past £50bn in 2021/22.
“This cost is split fairly evenly between the upfront income tax relief savers receive on their personal contributions and the NICs relief that applies to both employee and employer contributions.
“Over the last five years alone, the cost of pension tax relief has swelled by around £15 billion. It’s important to remember this isn’t money down the drain, however – it simply reflects a combination of the success of automatic enrolment in boosting savings levels in the UK and increased wages over that period.
“What’s more, every pound saved in a pension should help reduce the risk of that individual falling back on the state in their later years.
“At some point, the government will need to consider how to boost average pension contribution levels – although the pressure being placed on people’s incomes by spiralling inflation means that is unlikely to be a priority in the short-term.
“As we edge closer to the March Budget and with the Chancellor looking for cost savings, these latest figures will inevitably be seized upon by some as evidence pension tax relief should be fundamentally reformed.
“Discussions about the future of pension tax relief need to be focused squarely on ensuring more people are encouraged to save a decent amount for their financial future. Raiding pensions for short-term gain without considering the potential long-term consequences – something we have seen far too much of in the last decade – would risk undoing the early positive impact of auto-enrolment.
“Given the financial challenges facing millions of people already, saving for retirement likely already feels like a stretch for many. Any shift in the rules which undermines incentives to save for the long-term would risk being the straw that breaks the camel’s back.”
Hargreaves Lansdown senior pensions and retirement analyst Helen Morrissey says: “Pensions saved an impressive £51.6bn in income tax and National insurance in 2021-22, and are set to save us even more in the current tax year. The success of auto-enrolment has been an enormous contributor to this with over 10m people auto-enrolled into a workplace scheme and minimum contributions currently standing at 8 per cent.
“Pension tax relief is a real hidden hero of pensions with an £80 contribution from a basic rate taxpayer boosted to £100 while a higher rate taxpayer needs to contribute just £60 to get the boost to £100. However, relatively few people have even heard about tax relief, never mind understanding it, and so do not realise the impact it can have. As we come up to self-assessment deadlines it is a timely reminder for higher-rate taxpayers to check to see if they are claiming their higher-rate relief or they risk missing out.
“On the flip side there’s no getting away from the huge cost of pension tax relief to the government and it’s only likely to go higher as more people are enrolled and wages grow. For years there’s been speculation government might be tempted to trim tax relief to cut costs – so far, it’s been resisted but with budgets under pressure it may prove too tempting a prospect to leave.”
Hargreaves Lansdown senior personal finance analyst Sarah Coles says: “Isas are set to save us a massive £4.3bn in income tax and capital gains tax this tax year – up a fifth in a year. Given the endless tax rises coming this year, and the enormous pressure on our budgets, every penny we can save in tax makes a huge difference.
“We’re heading into a period of much higher taxes – where tax as a share of GDP will be higher than any other time since World War II. More taxpayers face being dragged into higher income tax bands by frozen thresholds. Meanwhile, the government is slashing the allowances for both CGT and dividend tax in April. It makes tax breaks more valuable than ever, so if you haven’t taken as much advantage of your ISA and pension allowances as makes sense for you this tax year, it’s well worth seeing what you can afford to free up this side of April.
“The figures also reveal the impact of rising interest rates on savings. The personal savings allowance (where the first £1,000 of interest is tax-free for basic rate taxpayers, and the first £500 is tax-free for higher rate taxpayers) is on track to save us £590m this year – up an impressive 69 per cent in a year. For many people, rising rates will also have pushed them over the threshold, so they will have started paying tax on their savings for the first time in a long time. It means that, particularly for higher earners, a cash Isa may offer the opportunity to save tax too.”
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