Higher-rate taxpayers: start your own pensions austerity drive

I've barely spent any money for two years. No tip-top holidays, no new cars, not much in the way of J Crew shopping sprees (one jacket in the sale doesn't count) and, apart from stuff I really need for work, no new technology (our pet rabbit ate the Amazon Fire box leads six months ago). Black Friday? It's nothing to me. Nothing.

Why this over-the-top self denial, you may ask? The sad answer is that at every Budget and Autumn Statement during these two years I have expected changes to be made to the tax relief available on pension contributions. So, as saving enough to prevent total misery in old age is really hard, I have been doing what I advise everyone else to do and taking what help I can get where I can get it.

Every spare penny has gone into my self-invested personal pension (Sipp). Every time a chancellor stands up, I expect him to confirm that he is cutting the relief to higher-rate taxpayers.

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And every time he doesn't, I feel a little relieved and also a little disappointed. Relieved because it gives me time to sock away a little more and I really need to. But disappointed because I'd like an excuse to spend some money on something other than pensions (as soon as 40%-plus relief is abolished, all funds will be diverted into my cedar hot-tub fund).

So when will that nice Philip Hammond finally release me from my own austerity hell? The answer, I think, is very soon. Read the consultation document that came with the Autumn Statement and you will soon see why.

Hammond notes that pension tax relief is one of the "most expensive" of all reliefs. He points out that some two-thirds of it goes to higher and additional rate taxpayers and that while the government is keen for everyone to save for old age, "it is important that resources focus where there is most need".

Let's look at these words and remember that the point of incentivising people to save is to support themselves in their retirement. It isn't to make sure that the well off stay well off. It is to ensure that as many people as possible save enough to support themselves in old age, so that the state doesn't have to. That's it. All the complications and fiddles introduced by Gordon Brown and George Osborne come down to this and this alone.

It's not about MoneyWeek readers being able to afford cruises when they are 75. It is about preventing an ageing population from bankrupting the UK. The question for whoever is unlucky enough to be chancellor is how much each oldie needs in order not to be a burden on the state for the majority of his or her retirement (we are putting the knotty problem of social care to one side here). And how should one organise tax incentives to make sure that, first, no one is able to put away much more than that (incentivising more is a waste of subsidy) and, second, that as many people as possible save as much as that?

It's tricky stuff. My guess is that the answer to the first bit is £20,000 a year. Add £20,000 to the full state pension and you have just over £26,000. That's not enough for a life of luxury but it's enough to get by without the state stepping in, particularly if you are in a couple and both of you are getting it.

Previous chancellors have told us as much. Before "pension freedoms", you used to be able to enter flexible drawdown if you had £20,000 of other pension income on the go (that is, enough for the state not to care what you did with the rest of your money).

The answer to the second question is tougher. The lifetime allowance of £1m and the annual allowance of £40,000 a year, tapered to £10,000 for high earners, are the first part of an attempt to get it right by limiting the absolute level of tax relief that high earners can get. The same goes for the cut in the contribution allowance for those already drawing money from their pensions. It was £10,000. It's now to be £4,000 (after a consultation). And my guess is that it will soon be zero. After all, if you can still afford to save, why are you drawing down in the first place?

But as you will understand, this still isn't particularly satisfactory from the government's point of view. An awful lot of those hitting £1m could afford to get there with way less tax relief. And the allowance system makes no odds to those who can't get there anyway. So change has to come. The Treasury told the FT on Thursday that there aren't plans afoot for the kind of change we have all been expecting. The chancellor, it says, "did not announce any further changes to pensions tax relief in the Autumn Statement and has no plans to do so". My own guess is that he most certainly does have plans (perhaps he hasn't told his department?) and that if he doesn't, he most certainly should have: cut tax relief to 20% a year for everyone and you'd save going on £15bn a year. And if anyone needs to save £15bn a year it's the UK government.

So what might happen next? You could see all relief cut to 20%. But more likely will be a shift to a flat-rate top up (higher than the basic rate of tax, lower than the higher) or even an age-based rate (less for older people, more for younger).

This might feel maddening for older higher-rate taxpayers (most of the suggested new relief systems have you subsidising everyone else) but if relief has to "focus where there is most need" that's the way it is going to be. You might also see more cuts in the lifetime allowance. This seems nuts given that most analysts think it should be abolished (as do I it's too complicated).

But go back to the £20,000 I mentioned earlier. There is a general rule of thumb in finance that retired people should use 4% of their pension every year. £20,000 is 4% of £500,000, not £1m.

So here's what you need to do if you are a higher-rate taxpayer with a pension that isn't yet anywhere near the lifetime allowance. Join my austerity drive. Put everything you can into your pension. That way you won't have to kick yourself when Mr Hammond abolishes your tax relief at his first real Budget. You'll also be able to spend the following year actually buying some stuff. I'll be in the hot-tub showroom.

This article was first published in the Financial Times