Tax  

Flat rate pension tax relief would leave earners better off

Flat rate pension tax relief would leave earners better off

A new report is urging the government to introduce a 30 per cent flat rate of tax relief, which "would be progressive, cost-neutral and leave three-quarters of earners better off".

According to analysis from the Royal Society of Arts (RSA) think-tank – led by former Labour adviser Matthew Taylor - 40 per cent of government spending on pension relief goes to the top 10 per cent of those claiming it, who earn £70,000 a year or more.

This is "deeply disproportionate" as they only make-up 24 per cent of pension contributions, RSA reported.

On the other hand, the report – which is based on data from HM Revenue & Customs (HMRC) – found that basic rate payers, comprising 75 per cent of those claiming any relief, pay more into pensions (51 per cent) but get only 32 per cent of pension tax relief.

In total, pensions relief costs HM Treasury £30.5bn, of which £11.8bn is spent on people earning more than £70,000.

The cost with tax relief is expected to increase even further in the next few years, as the government plans to increase minimum auto-enrolment contributions, scrap the earnings band and lower the age threshold to 18-years-old.

The current system, which RSA calls "deeply regressive", is giving basic rate payers fewer incentives to save, and especially hurts the growing ranks of the self-employed, who earn less than the average employee and have no employer topping-up their pension.

The think tank argued that reforming pension relief is therefore the only viable solution to under-saving among the self-employed, calling for a 30 per cent flat rate.

This flat rate would match relief to contribution: for every £1 savers wish to add to a pension, they would only need to contribute 70p – regardless of how much they earn or which tax bracket they fall into, the RSA said.

So if the top 10 per cent pay in 24 per cent, they get 24 per cent of the money spent on relief, rather than the current 40 per cent, it added.

RSA's analysis suggests three quarters of people would be better-off, and that such a move would be cost-neutral – even saving slightly -– for HM Treasury at year zero.

Any future additional costs could come from lowering the annual £40,000 pension allowance or ending employers' National Insurance contribution exemptions.

Mr Taylor, RSA's chief executive, authored the government's review of working practices in the modern economy, which recommended enabling self-employed to put aside 4 per cent of their income when completing tax returns.

He said: "Given they now make up one in six workers, it is time to stop assuming the self-employed are also self-sufficient.

"The Treasury should deliver on the prime minister's vow to prioritise ordinary working families, rather than the wealthy, when it comes to tax, and act for the real Middle England - hairdressers and taxi drivers on low and middle incomes, not top earners like me on £70,000 plus who the system currently subsidises.