Interactive Investor

Boris Johnson's income tax cut could prove costly for higher-rate pension savers

27th August 2019 09:33

Edmund Greaves from interactive investor

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While proposals to raise the higher rate income threshold would save better off earners tax, they would lose out on valuable pension contributions

In his pitch for the leadership of the Conservative Party, Boris Johnson called for the higher rate threshold for income tax to be raised from its current level of £50,000 to £80,000.

This would be good for workers (excluding Scotland where tax rates are devolved) earning between £50,000-£80,000 as they would no longer have to pay the higher rate of 40% on earnings above £50,000.

But the reforms would contain a sting in the tail for workers' pensions.

For example, a worker earning £60,000 per year that saved £5,000 into a pension each year would expect to pay £3,000 from their wage and received 40% tax relief - or £2,000.

But, if the threshold was moved the worker would have to contribute £4,000 to achieve a £5,000 total saving, as the tax relief would be trimmed back to 20%, in line with their income tax rate.

Pension provider Aegon is warning caution on these proposals. The firm says people could end up with a 25% reduction in their retirement income if they fail to make up the difference, or face swallowing the extra cost of topping up their pots.

Steven Cameron, pensions director at Aegon explains: “Increasing the higher rate income tax threshold from £50,000 to £80,000 will mean individuals earning over £50k will no longer pay 40% tax on that band of earnings. This will no doubt be very welcome and for those earning £80,000, could save them £6,000 a year in income tax.

"However, it also means those same individuals paying into pensions will no longer qualify for the higher rate tax relief which currently means a £5,000 pension contribution costs them only £3,000 after allowing for income tax savings. If these proposals are implemented, building up the same pot at retirement will cost them £4,000 after tax savings, or an extra £1,000 a year."

In recent days there has been much speculation about a possible 'emergency no-deal' Budget from Chancellor Sajid Javid. However, parliamentary arithmetic makes many different outcomes possible.

And while these income tax reforms are not guaranteed to happen, Mr Cameron urges people to be aware that were they to come into force, they should consider letting their pensions absorb some of the benefit of the income tax cut.

“While some may be tempted to keep the cost to them at £3,000, this will severely impact their ultimate retirement pot. It would mean the amount going in after adding on government tax relief would be £3,750, a quarter less than the previous £5,000. This also means the pension fund built up from future contributions and the income it could pay will be a quarter less," he says.

“If Boris does implement the increase in the higher rate tax threshold, the overall impact will still be an increase in after tax pay. While those contributing to pensions will see less of an increase, we hope this will be recognised as a price worth paying to keep retirement plans on course.”

This article was originally published in our sister magazine Moneywise, which ceased publication in August 2020.

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