Beware: the government could cut tax relief on pension contributions

The government may soon cut tax relief on private retirement savings, says David Prosser.

Will chancellor Rishi Sunak take the axe to tax relief on private pension savings? Successive chancellors have been rumoured to be considering such changes, only to desist. But there is growing concern in the pensions industry that Sunak might see the need to repair the public finances following Covid-19 as providing the cover he needs to act.

Pension-tax relief is certainly a tempting target. It cost the Treasury £21.2bn in the 2019-2020 financial year, the last for which data is available. And it is a relief that is more valuable to the wealthy: since savers get the relief at their highest marginal rate of income tax, higher-rate taxpayers get twice as much support when making the same pension contribution as basic-rate taxpayers.

Total abolition looks out of the question for any government, let alone one that professes to be an ally of savers taking personal responsibility for their financial futures. But there is a reasonably straightforward reform that would enable the chancellor to reduce the cost of pension-tax relief while simultaneously arguing that he is redistributing resources towards middle-income voters and the less well-off.

An extra 5%

The idea would be to introduce a flat rate of relief that everyone receives, irrespective of what income-tax rate they pay. Analysis suggests that a flat rate set at 25% would save the Treasury around £6bn a year. 

And while netting that very useful windfall, the chancellor would be able to point out that anyone on the basic rate of tax would be receiving an extra 5% of relief on their savings.

The big losers in such a scenario are savers who pay higher-rate or additional-rate income tax. At present, making £10,000 of pension contributions over the course of a year costs these savers only £6,000 and £5,500 respectively. With a 25% flat rate of relief, they would have to find £7,500 to reach the same level of total savings. Those not in a position to make up the shortfall would have to settle for lower pensions later in life.

Members of defined-benefit pension schemes might also run into problems. Their retirement benefits are guaranteed, but in calculating the cost of providing that promise, employers bank on tax reliefs at their current levels. With less relief on offer to some members, that might prompt further reviews of what is affordable.

Still, do not be surprised if the chancellor puts the objections of these groups aside. The Treasury has had an eye on higher-rate pensions relief for many years, but lacked the nerve to make a grab for it. Covid-19 might prove to be the once-in-a-lifetime opportunity to pounce.

In that case, wealthier savers may want to consider increasing pension contributions sooner rather than later. Some pension experts believe new tax-relief rates would have to be phased in over time; others point out that the announcement of reform would spark a “buy-now-while stocks-last” rush to make contributions while higher-rate relief is available. The chancellor may choose to pre-empt that possibility by making changes straight away.

Recommended

Britain’s most-bought shares w/e 1 July
Stocks and shares

Britain’s most-bought shares w/e 1 July

A look at Britain’s most-bought shares in the week ending 1 July, providing an insight into how investors are thinking and where opportunities may lie…
4 Jul 2022
M&G offers a solid 10.1% yield – but future growth is uncertain
Share tips

M&G offers a solid 10.1% yield – but future growth is uncertain

Financial services group M&G has one of the highest dividend yields in the FTSE 100. But it’s a complicated company, and a tough one to analyse, says …
4 Jul 2022
We’re doing well on pensions – but we still need to do better
Pensions

We’re doing well on pensions – but we still need to do better

Pensions auto-enrolment has vastly increased the number of people in the UK with retirement savings. But we’re still not engaged enough, says Merryn S…
4 Jul 2022
The income investor’s dilemma
Income investing

The income investor’s dilemma

Pay attention to dividend growth as well as initial yield when picking income trusts, says Max King.
4 Jul 2022

Most Popular

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks
European stockmarkets

Ray Dalio’s shrewd $10bn bet on the collapse of European stocks

Ray Dalio’s Bridgewater hedge fund is putting its money on a collapse in European stocks. It’s likely to pay off, says Matthew Lynn.
3 Jul 2022
UK house prices are definitely cooling off – but are they heading for a fall?
House prices

UK house prices are definitely cooling off – but are they heading for a fall?

UK house prices hit a fresh high in June, but as interest rates start to rise, the market is cooling John Stepek assesses just how much of an effect h…
30 Jun 2022
How to invest in copper, the most important metal in the world
Industrial metals

How to invest in copper, the most important metal in the world

As the world looks to electrify and try to move away from fossil fuels, copper looks set to be the biggest beneficiary. But how can you invest? Rupert…
30 Jun 2022