Interactive Investor

Treasury could cut higher-rate tax relief on pension payments

22nd March 2021 15:06

Marc Shoffman from interactive investor

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Move could save the taxpayer billions, but would be a blow for higher earners.

The Treasury could signal the end of higher-rate tax relief tomorrow, when it will unveil plans to reform the UK’s levies.

Rather than announce tax changes in the Budget earlier this month, the Treasury has decided to hold a ‘tax day’ where a range of consultations will be announced on reforms it wants to make.

One rumoured change is a cut to higher-rate tax relief.

All savers putting money into a pension currently get tax relief at the basic rate of 20%. This is an extra government boost to your contributions that takes what you would have paid in income tax and puts it in your pension instead.

Higher earners, those with income above £50,000 can get 40% tax relief, and those earning more than £150,000 get 45%.

They need to claim the extra 20% or 25% through a self-assessment tax return unless their contributions are sent directly from their salary.

Paying for these reliefs is estimated to cost the Treasury, or taxpayer, £40 billion a year.

That is a lot of money to spend, especially when the government wants to balance the books and reclaim billions of pounds of state support during the pandemic.

Chancellor Rishi Sunak is reported to be planning to scrap the current reliefs and replace them with a flat rate of 20% or 25%.

This would halve the reliefs high earners receive, and lower their pension contributions.

Steven Cameron, pensions director at Aegon, says the chancellor may not have much choice when it comes to taxes he wants to change.

He adds: “Pension tax relief was left unchanged other than freezing the lifetime allowance in the Budget. There were also no changes to wealth taxes such as capital gains and inheritance tax.

“But with his hands tied by a manifesto commitment not to increase income tax, national insurance or VAT, the chancellor may have future plans to make changes in these areas, while also seeking to boost the green economy and deliver intergenerational fairness.”

James Jones-Tinsley, a technical specialist at pensions consultancy Barnett Waddingham, warns a “significant reduction” of pensions tax relief would be a mistake.

He says: “Tax relief is a highly effective way of incentivising people to put money into their pension that will be topped up by the government.

“Instead, the chancellor should address the fact that the tax relief system is complicated and largely misunderstood.

“Introducing a flat-rate of tax relief of at least 30% for everyone, regardless of earnings, would encourage basic rate taxpayers to save into a pension, while not over-penalising higher-rate taxpayers.”

He suggests simplifying the relief at an attractive rate for all would reap longer-term rewards. 

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