Tax relief changes would 'create few winners'

The two most discussed forms of pensions tax relief changes would hit high earners hard and not significantly improve the retirement income of lower and median earners, the Pensions and Lifetime Savings Association (PLSA) has warned.

Analysis of the Pensions Policy Institute's (PPI) recent modelling by the PLSA found that removing the higher rate of relief and introducing a new single rate of relief at 25 per cent would not benefit the group, but would result in reduced pension income for millions of others who pay higher rate income tax.

The PLSA's Pension Tax Reform: Implications for Savers report asserted that, if higher rate tax relief was removed and everyone received a single rate of relief at 20 per cent, a person on median earnings throughout their working life would see no change to their pension contributions or tax bill.

Meanwhile, a single rate of 25 per cent would result in an increase in private pension income of between 5 and 8 per cent for the same person.

This would amount to an extra £200 per year for someone putting away the 8 per cent minimum automatic enrolment contribution level.

However, the saver’s overall replacement rate would stand at 53 per cent under the 25 per cent single rate of relief, compared to 52 per cent under the current system, meaning only a very small increase in income.

In the case of a single rate of 20 per cent being introduced, a higher rate taxpayer, who was earning £29,000 per year at age 22 and £64,000 per year at age 68, would pay between £34,500 and £205,700 in extra tax over a working lifetime.

The PLSA stated that the resulting reduced pension contributions would lead to the high earner’s retirement income falling by between £900 per year and £7,500 per year, depending on the type of scheme, with this amounting to a reduction in private pension income of over 20 per cent in all scheme types.

With a single rate of 25 per cent being brought in, the same saver would pay between £26,300 and £150,400 in additional tax and receive around a 16 per cent reduction in private pension income.

As such, the PLSA noted that, though the scrapping of some or all higher rate relief could net the Treasury between £3.5bn and £10bn per year, the policy would result in lower pensions for many.

PLSA director of policy and advocacy, Nigel Peaple, said: “While it might seem reasonable to reduce tax relief for the 13 per cent of the working population who pay higher rate income tax, it should be remembered that many more than 13 per cent of taxpayers will earn this amount at some time, and many only for a short number of years towards the end of their careers – when pension saving is often at its highest.

“The PLSA estimates that the removal of higher rate tax relief on pension contributions could result in around 3-4 million taxpayers each paying an average of £2,000 more tax each year; money that would otherwise have gone into their pensions.”

As such, he argued that the current system of pension taxation “should be maintained to encourage an adequate level of saving for all”, but urged the government to consider the PLSA’s principles for pension taxation and “consult extensively” if it did choose to push ahead with reforms.

He concluded: “The difficulty in achieving adequate levels of income in retirement set out in our report, highlights the case for increasing the statutory minimum under automatic enrolment pension saving, not taking actions that result in less saving.”

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