Budget pension tax relief shake-up looks unlikely

Budget pension tax relief shake-up looks unlikely

The Treasury response to the Treasury select committee's suggestions on savings contained an interesting statement.

HM Treasury stated: "While the government keeps all taxes under review, no consensus for either incremental or more radical reform of pensions tax relief has emerged since the consultation in 2015."

Is there really no consensus? After all, report after report suggests flat rate relief would be fairer. 

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Let's explore the suggestion a bit and walk up and poke the obstacles to see if they are real or not. In order to do that we need to list the ways in which relief is given:

Tax-free lump sums

The gross cost of pension tax relief to the government is £38.6bn. But £13.5bn is received in tax receipts on pension payments taking the net cost down to £25.2bn.

The tax paid of £13.5bn is net of 25 per cent paid tax free (roughly) or another £4.33bn. This routinely gets forgotten about in the perennial cry that it is not tax relief but tax deferral.

It is not – if you save in a pension the most you will pay is tax on three quarters of what you saved, based on current law and not extracting it all at once if you were a basic rate taxpayer in employment.

There is another not so easily quantified amount that is also implicit.

People are relieved at marginal rate and are taxed at average rate. The average rate is determined by how much is covered by personal allowance, and the basic and higher rate bands. 

So even a basic rate taxpayer who will have received 20 per cent relief on all pension contributions may have at least some of their pension covered by their personal allowance.

In practice the average tax rate for a person fully utilising the basic rate band is currently 15 per cent. If that’s all pension income then that’s another 5 per cent relief.

This is obstacle one – there is already a large tax incentive to join a pension. Increasing tax relief for basic rate taxpayers via a flat rate is unlikely to increase savings – if you can't afford to save, you can't afford to save regardless of the carrot being offered.

Employer relief

If an employer makes a contribution to a pension scheme they claim a deduction in their accounts and, if it is an occupational scheme, that is it.

No tax, no National Insurance on the recipient of such largesse and because of that employer NI saving this has become part of the flexible benefit/salary sacrifice industry.

If higher rate relief on employee contributions was removed to pay or part-fund flat-rate relief then there would either be an explosion in salary sacrifice or there would need to be changes that brought these contributions into the new rules.