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Cost of pension tax relief vs tax revenues – now is not the time to slash saving incentives say experts

1 March 2018

The cost of pensions tax relief remained stable in 2016/17, while personal pension contributions hit a record high during the same period, new figures from HM Revenue & Customs have shown.

Pension tax relief was £38.6bn in 2016/17, just marginally up from the £38.5bn recorded the previous tax year. While personal pension contributions hit a record high in the same period of £24.6 billion.

The net cost of tax relief, which takes into account tax taken from pensions in payment, was £25.2 billion in 2016/17, compared to £25.1bn the previous year.

Tom Selby, senior analyst at AJ Bell, commented: “While most would have expected the tax relief bill to soar as automatic enrolment continues to be rolled out to millions more employees and employers, it appears the introduction of the annual allowance taper – which reduces the pension savings incentives for higher earners – has stemmed the tide somewhat. That said, the cost is likely to spiral ever higher as minimum auto-enrolment contributions are scaled up from 2% today to 8% from April 2019.

“On one hand, an annual bill £25.2 billion and rising could be viewed as increasingly unsustainable. On the other hand, average pension savings levels in the UK remain far too low. Pulling the tax relief rug from under the system now – just as minimum auto-enrolment contributions edge northwards and people get used to the idea of sacrificing some of their hard-earned salary for retirement – would be a huge risk and could potentially undermine the entire reform programme.”

Steven Cameron, pensions director at Aegon, said the figures highlight both interesting and at times, worrying trends.

“First, the amount of tax relief granted by HMRC on pension contributions has increased over the last 10 years by 25% from £30.6bn to £38.6bn. However, the increase in tax receipts on pensions in payment have increased more quickly by over 43% from £9.3bn to £13.5bn. Tax paid on pensions in payment is likely to continue to rise as many current pensioners and those retiring in the coming years continue to benefit from generous defined benefit pensions.

“Auto enrolment is leading to more people being in defined contribution workplace pensions, and while minimum contributions to these are about to increase, they will still typically be far less generous that the defined benefit schemes of the past.”

Cameron added that most tax relief being granted on pension contributions is on those from the employer rather than the employee. “82% is on employer contributions, showing that employers continue to pay in the vast majority. A significant part of this is likely to be employers paying in additional sums to defined benefit schemes to make up for funding shortfalls.”

In bad news for the self-employed, tax relief on pensions contributions for the sector remained low at £700m, significantly lower than the £1.3bn recorded in 2007/08.

Cameron added: “The figures for the self-employed are particularly worrying. Contributions from them have fallen to only £700m in 2016-17. This is against a rising number of self-employed, highlighting just how important it is to find ways of encouraging greater pension provision amongst the self-employed.”

Selby called for an independent savings commission similar to the Turner Review that eventually led to auto-enrolment, which could build a lasting cross-party consensus on pension saving incentives.

He added: “If this could be achieved we might move permanently away from the pantomime politics that usually precedes a Budget statement, with savers often reacting to a blizzard of rumour and speculation. Failing to address this now will be a huge opportunity missed. At a time when the Government is often accused of naval gazing, the Chancellor could show a genuine long-term commitment to delivering stability for savers.”


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