Defined Benefit  

Warning tax relief cut could lead to DB contribution hike

Warning tax relief cut could lead to DB contribution hike

Employers and staff might have to increase their contributions to defined benefit schemes if a rumoured cut to the 40 per cent relief for higher taxpayers goes ahead, Aegon has warned.

According to The Times, Rishi Sunak, the new chancellor of the Exchequer, plans to press ahead with cuts to pensions tax relief for high earners in the upcoming March Budget.

Under current rules tax relief is paid on savers' pension contributions at the rate of income tax they pay.

This system costs the Treasury almost £40bn a year in lost tax revenue but cutting tax relief on pension contributions to 20 per cent, rather than the 40 per cent enjoyed by higher earners, could help raise £10bn a year.

Steven Cameron, pensions director at Aegon, noted in defined contribution schemes the impact of this cut could be a reduction in members’ future pensions as it may discourage some from saving into pensions, but he warned the implications for DB were far less clear.

“Here, the individual is promised a certain pension at retirement. Their contributions are fixed, tax relief top ups are paid to the scheme and the employer pays whatever extra is needed to balance the funding of promised benefits across the membership. 

“If the government cuts the top ups for higher rate taxpayers, either the members will have to pay more or the employer will have even greater balancing contributions.

“Neither will be welcomed so this could be yet another prompt to close the few remaining 'gold plated' DB pensions in the private sector.”

Mr Cameron noted while few final salary schemes remained open in the private sector, they were common in the public sector.

“Any changes to tax treatment of pensions would need to apply here too to avoid divisive preferential treatment for public sector employees.

“So the government will face explaining significant contribution increases for public sector higher rate tax payers or finding additional funds from public sector employers, which ultimately may have to be paid for by general taxpayers.

“This is one of many complexities that need to be fully thought through ahead of any reform of the tax treatment of pensions.”

Ricky Chan, director and chartered financial planner at IFS Wealth and Pensions, said: "Using a very simple example, if a higher rate tax payer’s gross pension contribution is supposed to be £100 per month (including tax relief), the loss of the higher rate tax relief could mean that the gross pension contribution would be just £80 per month.

"The difference of £20 would need to be made up from somewhere – if the employer shoulders this burden, then the increase in costs is likely result in more DB scheme closures. Unless of course, the employees are willing to reduce their pay to make up the difference."

He added: "Similarly, if DB schemes in the public sector remain open then it could mean that the government has to fork out more to pay for these 'gold plated' pensions, thereby widening the 'pension wealth gap' between those lucky enough to be still be in one and those without.