The Chancellor has been “urged” to raid the pension savings of middle class workers, despite previously saying she has “no plans” to change the current setup.
Rachel Reeves has not categorically ruled out a change to pension taxation, and new reports suggested she will ‘consider’ Treasury proposals for a flat 30 per cent rate of pension tax relief.
Experts have said the changes would be difficult to implement because of the complexity of the system.
The Treasury has not responded to the claims, which were first reported in The Telegraph.
But if the changes did come into force, how would the proposals affect you and your money? i spoke to experts to find out.
What is the current scheme?
Contributions to pensions currently benefit from tax relief at a “marginal rate”, meaning basic rate taxpayers get 20 per cent, higher-rate taxpayers 40 per cent and additional-rate taxpayers 45 per cent.
In simple terms, in a defined contribution scheme like a personal pension, when you pay in £80, HMRC tops up by £20 (basic rate relief) to give a “gross” contribution of £100.
A higher rate taxpayer can record this £100 contribution on their tax return and get another £20 in tax relief – so it costs a higher rate taxpayer only £60 to get £100 into a pension.
To limit the cost of tax relief to the Exchequer, most people have an annual allowance of £60,000, although those who have flexibly accessed their pension and very high earners have a lower allowance.
In addition, there are limits on the lump sums people can pass on from their pensions to their nominated beneficiaries when they die.
What are the ‘proposals’?
The Chancellor will reportedly be urged by Treasury officials to consider introducing a flat 30 per cent rate of tax relief.
It would mean higher rate payers, those earning over £50,271, will pay an effective 10 per cent tax charge on their pension and the current tiered rate of pension tax relief would be merged into a new flat rate of either 20 per cent or 30 per cent.
The plan would affect up to six million higher rate taxpayers and cost the wealthiest people around £2,600 a year, according to figures from the Institute for Fiscal Studies (IFS).
However, the changes would increase the attractiveness of pension saving for basic rate taxpayers, according to Becky O’Connor, Director of Public Affairs at Pensionbee.
She said: “It would mean a significant increase in the attractiveness of pension saving for basic rate taxpayers, as a £100 contribution would cost them £70 rather than £80.
“Whereas for higher and additional rate taxpayers, the attractiveness of pension saving – while still significant compared with other ways of saving for retirement, would diminish. Higher rate taxpayers currently only have to put in £60 for this to be topped up to £100 by the Government. Under a 30 per cent flat rate system, this would go up to £70 to reach the same personal contribution.”
The Government has pledged to not raise the main rates of income tax, national insurance or VAT which means it may be limited in terms of what it can borrow.
Pension tax relief “costs” it £50bn so making adjustments could ‘save’ it money.
How likely is it that the changes will come into play?
Experts say the system is very complicated so would be difficult to adjust.
Steve Webb, former pensions minister and partner at consultants LCP, said: “For decades, cash-strapped governments have looked jealously at the cost of pension tax relief and tried to find ways of raiding it. But the system is so complex and the number of losers so large that it has always proven difficult.
“In the past, governments have come up with ideas like annual limits on contributions and lifetime limits on pension pots in order to limit the benefit to the wealthiest, whereas ideas like flat rate tax relief could affect millions of people, not all of whom would consider themselves well off.”
He added that although Rachel Reeves, in opposition, has repeatedly said that she favours a flat rate or that too much tax relief goes to high earners, it’s one thing to say it in opposition and quite another to implement it in government.
Tom Selby, Director of Public Policy at AJ Bell, added: “The potential for a raid on retirement savings incentives is a rumour that does the rounds before pretty much every Budget.
“The most common pre-Budget pension tax relief speculation centres around the future of higher-rate pension relief and the potential to introduce a flat rate of pension tax relief.”
But Selby said that introducing a flat rate of relief is “much easier said than done” as a large chunk of any potential savings to the Treasury from a pension tax relief raid would come from defined benefit (DB) schemes, the majority of which now reside in the public sector.
He added: “If a flat rate of pension tax relief below 40 per cent were applied on these schemes, the only way to ensure the correct level of tax relief was applied to contributions from higher and additional-rate taxpayers would be to hit those members with a tax charge likely running into thousands of pounds.
“This would therefore risk opening up a blistering row with NHS staff and civil servants at a time when many public services are already stretched to breaking point.”
Additionally, reducing the upfront incentive for people to save in a pension would also run counter to wider government efforts to boost long-term investing and risk undermining the flagship automatic enrolment reforms.
Younger people who are less likely to have benefitted from higher-rate tax relief may also feel understandably aggrieved that a benefit offered to the previous generation has been ripped away from them.
What could the Chancellor do instead?
Selby said: “Having ruled out reintroducing the lifetime allowance, there remains the possibility that the annual allowance could be tinkered with to raise some much-needed cash.
“But again, this would sit uncomfortably with the broader investing agenda and rub up against this government’s overarching mission of delivering stability.”