Flat rate pension tax relief would leave 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.

I am not sure the government has the appetite for that right now.Tom McPhail

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.

"Overhauling an outdated and indefensibly regressive system, alongside introducing collective defined contribution [CDC] pensions, would showcase the government’s serious commitment to social reform."

According to Tom McPhail, head of policy at Hargreaves Lansdown, the government has unfinished business with pension tax reform.

He said: "The idea of moving to a flat rate is well-tested and would garner support in many quarters.

"However pension taxation is notoriously complicated and any move to reform the central pillar of the system would necessitate a more comprehensive review of the multitude of quirks and wrinkles which bedevil pension planning.

"I am not sure the government has the appetite for that right now."

maria.espadinha@ft.com