Reports speculating that Chancellor of the Exchequer Sajid Javid will announce cuts to the pension tax relief in next month’s Budget, have drawn warnings from experts that changes would raise complexities that could severely dent savers’ confidence in pensions, a “step too far” that would result in a diminished pensions savings environment.
One of the ideas currently being considered by the Chancellor includes cutting pension tax relief for those earning £50,000 a year or above from the current 40% rate to 20%.
It is estimated introducing a flat 20% rate could save the government more than £10 billion a year but would leave more than four million people worse off.
Kay Ingram, director of Public Policy at national financial planning firm LEBC, said any change which restricts the rate of relief to a flat rate, or the basic rate, “will hit middle aged middle earners hardest; it is likely to result in less being saved for retirement and many people forced to work longer.
“This cohort of 38-55 year olds earning above £50,000 are less well prepared for retirement. They did not have the advantage of defined benefit pensions to the same extent as older workers, and unlike younger workers, were not offered auto enrolment at the beginning of their careers.
“Their pensions will be largely dependent on investment returns. Guaranteed rates of return are much lower as a result of low interest rate policies, so a higher level of savings is required to achieve an acceptable retirement income. Their State pension age has been raised to 67/68. To remove higher rate tax relief at this stage would make it even harder for them to retire and is a step too far given that the annual and lifetime allowances already restrict the amount of relief any individual may claim.”
Fiona Tait, technical director, Intelligent Pensions, said: “While I can certainly see the attraction of a single flat rate of pension tax relief, 20% is at the lower end of range of reliefs discussed in previous consultations which would mean far less money would enter into the pension system as a whole.
“I would suggest that some proper modelling is carried out to assess whether 20% is in fact the most suitable rate or just convenient for a government who wants to keep the cost of tax relief to a minimum.
Aegon pensions director Steven Cameron has called on the Chancellor to consult fully rather than going too far, too fast in the March Budget and creating adverse consequences.
He said: “Simply removing higher rate relief and granting 20% relief to everyone would not affect basic rate pension savers but would severely dent the attractions for higher rate taxpayers many of whom are far from “wealthy”.
“While there are benefits in flat rate relief, when the Government considered such changes back in 2015, it found there are many complexities to consider, and unless these are thought through and solved, changes could do more harm than good.
“Rushing to cut pensions tax relief could do long term damage to UK retirement savings so we urge the Chancellor and his team to avoid going too far, too fast and instead to engage with the industry to resolve issues. We also recommend testing any new approach with savers to understand how it might change retirement savings behaviours.”
According to Cameron, the government would need to consider three key issues before it implements a policy change; employer contributions, salary sacrifice and defined benefit pension schemes.
Currently, employer contributions into an employees’ personal pension are treated as a business expense and will reduce the employer’s corporation tax bill. Any reforms would need to not only consider employee contributions, but whether there is a need to change the tax treatment of employer contributions to avoid any unintended consequences.
An added complication is that some schemes and employers have ‘salary sacrifice’ arrangements in place, allowing them to pay contributions on their employees’ behalf in return for a cut in salary. This means the total contribution is considered an employer contribution with corresponding tax treatments, which can offer tax benefits to some employees and employers. If a flat rate of tax relief was introduced below an individual’s income tax rate, they would benefit from choosing this option, creating a loophole, Cameron warned.
Defined benefit scheme issues
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