‘Temptation’ for govt as pension tax relief rises to £42.7bn

‘Temptation’ for govt as pension tax relief rises to £42.7bn

The government could be tempted to cut pensions tax relief amid rising costs expected to reach £42.7bn in 2020/21.

Data from HM Revenue and Customs showed the estimated cost of pension tax relief in 2020/21 is £42.7bn, split between £22.9bn in income tax and £19.8bn in National Insurance contributions.

The cost has been rising steadily from the estimated £41.3bn in 2019-20 and £38.2bn in 2018-19.

Tax relief on pension contributions is paid at the saver's marginal rate of income tax, meaning basic rate taxpayers get 20 per cent pension tax relief, increasing to 40 per cent for higher-rate taxpayers and 45 per cent for additional-rate taxpayers.

The data also showed employer contributions to occupational schemes received £21.1bn in relief throughout 2019 to 2020, £8.6bn of which was in the public sector. 

Meanwhile, employer tax relief on contributions to defined benefit pensions increased by £400m to £15bn over the four years to 2019/20, while tax relief on contributions to defined contribution (DC) schemes increased £4bn to £11.6bn.

The ever rising cost could fuel further speculation about future cuts to pension tax relief.

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said it was clear to see why when the figures keep going up and it is one of the “biggest burdens the government must shoulder”.

Morrissey said: “While defined benefit pensions still account for a lot of the cost, we can see the increasing impact of auto-enrolment with tax relief for defined contribution schemes on the rise.

“OBR predicts average earnings will fall next year and this will bring a corresponding decrease in pension tax relief. Whether this will be enough to stop the government trimming pension tax relief to pay its enormous Covid bill in the near future remains to be seen."

But Steven Cameron, pensions director at Aegon, said the headline figure of how much pensions tax relief ‘costs’ the government hides the underlying factors. 

Cameron said: “Pensions in payment are, after the tax free cash aspect, subject to income tax in payment, so much of the ‘cost’ is temporary. 

“The figure also mixes employer and employee contributions and to date, suggestions for pensions tax relief reform have focussed on employee tax relief, although moving to a flat rate might require higher rate taxpayers to have employer contributions taxed as a benefit in kind to avoid a salary sacrifice loophole. 

“The other major factor is defined benefit v defined contribution. Reforms will be particularly complex for DB but omitting the latter would be grossly unfair and would also significantly reduce any ‘saving’ for the Treasury.”

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