Tax Relief

Warning: the federal government may lower tax breaks for pension contributions

Will Chancellor Rishi Sunak seek tax breaks for private retirement provision? It is rumored that successive chancellors are considering such changes only to refrain. However, there is growing concern in the pension industry that Sunak is seeing the need to reorganize public finances following Covid-19 as cover for its actions.

Pension tax breaks are certainly a tempting goal. It cost the Treasury Department £ 21.2 billion in fiscal 2019-2020, the last for which data is available. And it is a relief that is more valuable for the wealthy: Since savers are relieved at the highest marginal tax rate, higher taxpayers receive twice as much support as basic taxpayers for the same pension contribution.

A total abolition is out of the question for any government, let alone one that acknowledges itself as an ally of savers who take personal responsibility for their financial future. But there is a reasonably simple reform that would allow the Chancellor to cut the cost of pension tax breaks while arguing that he is redistributing resources among middle-income voters and the less affluent.

Additional 5%

The idea would be to introduce a flat rate relief that everyone receives regardless of the income tax rate they pay. Analysis suggests that a flat rate of 25% would save the Treasury Department around £ 6 billion a year.

And while the Chancellor is offsetting this very useful stroke of luck, she could point out that anyone who receives the base tax rate will receive an additional 5% relief on their savings.

The big losers in such a scenario are the savers who pay higher or additional income tax. It currently costs only £ 6,000 or £ 5,500 for these savers to make a pension of £ 10,000 over a year. With a 25% lump sum relief, they would have to pay £ 7,500 to get the same level of total savings. Those who cannot make up for the shortfall will have to settle for lower pensions later.

Members of defined benefit pension schemes may also encounter problems. Your pension benefits are guaranteed, but when calculating the cost of fulfilling this promise, employers rely on tax breaks at their current level. With fewer facilities being offered to some members, this could lead to further affordability reviews.

However, do not be surprised if the Chancellor puts the objections of these groups aside. The Treasury Department has had a higher pension relief in mind for many years, but it has lacked the courage to reach for it. Covid-19 could prove to be the golden opportunity to pounce.

In this case, wealthier savers should consider increasing their pension contributions sooner rather than later. Some pension experts believe that new tax breaks will need to be introduced over time; others suggest that the reform announcement would create a rush to “buy now while supplies last” to contribute while higher interest rate relief is available. The Chancellor can anticipate this possibility by making changes immediately.

Related Articles