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How tax relief tinkering will harm younger savers

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How tax relief tinkering will harm younger savers
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Now more than ever people are having it drummed into them that saving at an early age is imperative for a good retirement, hence the push for auto-enrolment to get those aged 22 and over to think about pensions.

So it is odd that the government almost appears to contradict itself with rumours swirling that it could look to cut higher rate tax relief on pensions in order to pay off some of its Covid debts.

Steven Cameron, pensions director at Aegon, has previously warned these proposals, while also keeping the state pension triple lock, would hurt younger generations the most and create intergenerational unfairness.

But why is this?

Disincentivising the younger generation

Tax relief is paid on pension contributions at the highest rate of income tax a person pays. 

So basic rate taxpayers get 20 per cent pension tax relief, higher rate taxpayers can claim 40 per cent and additional rate taxpayers get 45 per cent. 

Toby Bentley, a financial adviser at Lathe & Co, says if young, higher rate taxpayers were to lose out on this 40 per cent, not only do they lose out on additional contributions, but also the investment growth that would go along with it. 

“This massively disincentivises younger higher rate taxpayers who would pay higher rate tax or additional rate tax their whole working life, without receiving that tax back via a pension contribution, only to then have to potentially pay higher rate tax or additional rate tax again when they draw an income from the pension itself,” Bentley explains.

The triple lock, which guarantees the state pension will go up by the highest out of inflation, wage growth or 2.5 per cent, adds to the unfairness felt by young people, Cameron argued.

This is because retaining the triple lock without adjustment is likely to grant state pensioners a windfall increase next April, which will be paid for by the working age population.

This would not go down well if these people were to see their own pensions cut via a drop in tax relief.

Holly Mackay, chief executive of Boring Money, says tax relief is the main bribe for asking people to save for retirement and if you take this away then the government will just be exacerbating an already substantial problem.

“Pensions remain unloved and poorly understood; 81 per cent of under 40s say they wouldn’t feel confident opening a new personal pension, illustrating that young people are not at home picking a retirement product," Mackay adds.

“There are difficult trade-offs to be made but the chancellor is going to have to decide whether to rob younger Peters to pay older Pauls, and I find that an unjustifiable prospect.”

But Rebecca Aldridge, managing director of Balance Wealth Planning, argued that younger savers will most likely be basic rate taxpayers who will not be as adversely affected, although it could put people off of saving.

She says: “The loss of higher rate tax relief, as well as the miserly lifetime allowance will put people off. I’d like to think people will save into Isas instead, although as a nation of property lovers, my fear is that this will drive more people to buy rental properties, which causes a whole lot of issues for us as a country.