Minister for Pensions Steve Webb has proposed for the pensions tax relief for earners in the 40 and 45 per cent higher tax bracket to be scrapped and be replaced with a 33 per cent flat rate tax relief.

Speaking at an event on welfare and tax reform at the Resolution Foundation on Wednesday 11 February, Webb said it would be quite interesting if the cost neutral rate of tax relief is not 30 per cent, as he previously proposed, but instead 33 per cent.

“You would be able to say to the public who don’t understand tax relief and don’t see it and aren’t incentivised to save by it, for every £2 you put in a pension, the government will put in £1,” he explained.

He continued; “I don’t believe tax relief incentivises saving other than amongst the very rich, but that might actually have some impact, I think I could sell that.”

The idea of introducing a flat rate 33 per cent tax relief was originally proposed in a report by the Centre for Policy Studies in April 2014. Author of the report and research fellow Michael Johnson said the reform would be a significant step forward to improving the effectiveness of HMT’s investment, the purpose of which should be to encourage people to save more.

“Today’s framework of tax relief is faced with a fundamental conundrum. Given that income tax is progressive, then tax relief is regressive, so much so that it is more of a personal tax management tool for the wealthy than an incentive to save. There is plenty of evidence that the wealthy will save anyway, regardless of a 40% or 45% tax relief,” he added.

Currently, none of the political parties’ manifestos plan to introduce a flat rate tax rate. The Conservatives have no plan to review pension taxation but believe the way to control tax relief is by turning the dial on the annual allowance and the lifetime allowance, which are £40,000 and £1.25m respectively.

Labour plan to restrict tax relief for 45 per cent taxpayers to just 20 per cent, using the money saved to help fund the jobs guarantee pledge. They has no current plans to restrict higher rate relief or to adjust the annual or lifetime allowances.

The Liberal Democrats official line is they would only review tax relief and possibly move to a flat rate. However, they would restrict the lifetime allowance to £1m.

Hargreaves Lansdown head of pensions research Tom McPhail said their view is that pension tax policy should be left unchanged until towards the end of the next parliament at the earliest.

“It is worth noting that no one has any clear idea how investors will respond to the new pension freedoms. Even well-informed predictions can be very wrong. In the planning stages of auto-enrolment, it was widely believed that opt-out rates would be in the region of 30 per cent (DWP and PPI); in fact so far they have been below 10 per cent. A reduction to tax reliefs could have a similar, though less welcome effect.”

“A flat rate of relief for all would certainly be simpler, eventually and would enable clearer messaging around the concept of ‘you pay 3 and get one free’. The transition would be highly disruptive though as many schemes would have to rebuild their computer systems. Again,” he added.

Unbiased.co.uk chief executive Karen Barrett said if the proposals go through we will see a more “streamlined system”, which should make it easier for people to understand how tax relief works.

“Our research with Prudential found that an additional £2.9bn could be saved annually in tax as a result of more people taking better advantage of the pension tax breaks available,” she stated.

However, she added that although the proposal should help encourage more basic rate tax payers to save, she hopes it will not discourage higher rate tax payers from saving into pensions as it is “still the most effective vehicle for saving for retirement”.

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