Pension contributions will cost a little more after mini-Budget

Our head of pensions and savings Rebecca O'Connor explains the impact of the basic rate income tax reduction from 20% to 19%.

On the impact of the upcoming reduction in basic rate income tax from April next year on pension tax relief:

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “On the face of it, a reduction in the basic income tax rate appears to mean poorer retirement outcomes for pension savers. But the way pension contributions work in most workplace schemes means that the overall contribution will remain the same, but the cost of this to the individual will increase slightly. 

“As a basic example, if someone is paying £100 a month into their pension, the ‘cost’ to them of doing so becomes £81 rather than £80 following the income tax reduction. For most people paying this amount into a workplace scheme, the overall contribution will remain the same, but they would be paying £1 a month more for the privilege.

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“The amount of tax relief they would receive as a proportion of their personal contribution declines from 25% to 23.45% of the amount they put in, but in most cases, the overall contribution will be the same. 

“If some people choose to keep their personal contribution at £80 rather than maintain an overall contribution of £100 a month, this would mean that the overall amount going into their pension would drop slightly, to £98.76, losing £1.24 a month from their pension, or almost £15 a year.

“The more people contribute to their pension, the more they’d feel the impact. But even someone paying in £500 a month – much higher than typical contributions for someone on an average salary – and their overall contribution remained the same, retaining their overall contribution at the same level would cost them £5 a month more, or £60 more over a year. 

“Overall, this is highly unlikely to dissuade people from continuing to pay into their pensions.”

For ‘relief at source’ schemes (including SIPPs):

“There are different ways pension schemes apply tax relief to pension contributions: relief at source, net pay and salary sacrifice. 

“As a result of the chancellor’s changes today, there is an extra year of relief at the current rate of basic income tax until 2024 for pension savers in ‘relief at source’ schemes, such as Self-Invested Personal Pension holders. So they will continue to benefit from 20% tax relief on contributions at the basic rate, while paying the lower amount of income tax on basic rate earnings at 19%, for one year.”