Pension tax relief has come under fire this month as the three main political parties unveiled their election manifestos.
First to be revealed was the Labour plan to restrict tax relief for top-rate taxpayers (around 300,000 people) to the same level as basic-rate payers: i.e. 20 per cent. The cut would begin at £150,000, tapering to 20 per cent at £180,000. Labour’s home for the cash saved would be to pay for a reduction in the maximum level of university tuition fees to £6,000 from the current £9,000.
The Conservatives plan to enact their version of a reduction in tax relief by gradually reducing the annual allowance from £40,000 for those earning £150,000 per year to £10,000 for those earning £210,000. The Conservative sweetener to win votes on 7 May is an increase in the inheritance tax allowance, effectively allowing a house worth up to £1m to be inherited free from IHT.
The Liberal Democrats proposed the most radical reforms by announcing plans to look into a flat rate of pension tax relief. Current pensions minister Steve Webb has played a significant role in the pension reforms of this Parliament and a flat rate of tax relief could be up for debate if he forms part of another coalition.
While reform of IHT is welcome, vote-winning policy should not be introduced at the expense of one of the key forces behind long-term savings in the UK.
Tax relief on pension contributions is founded on the basic principle that those who work hard and subsequently increase their taxable earnings receive an equal and opposite incentive to save for the long term. Government pension contributions are linked to hard work and self-improvement and to break the link between tax paid on income and tax relief on pension contributions is to disregard the entire principal that underpins this important savings incentive. Seen in this context, reducing tax relief on pensions risks damaging the UK’s reputation for encouraging and rewarding aspiration.
The logic for a flat rate of tax relief is that it should incentivise basic rate taxpayers to save more into a pension. However, research we commissioned from YouGov indicates this may not follow as consumer understanding of the pension tax relief system is extremely limited. Less than half (43 per cent) of people are aware that higher rate taxpayers receive a higher level of tax relief on pension contributions. More than one in ten (16 per cent) think we already have a flat rate, while 7 per cent believe higher earners receive less. More than a third admit to having no idea at all.
These figures suggest awareness is limited to the extent that the impact of introducing a flat rate of tax relief is hard to predict and would by no means guarantee an increase in saving. It is possible some basic rate taxpayers may even feel the increase in Government contributions could afford them a decrease in their own personal contribution.
The dust is yet to settle following the introduction of the Coalition’s freedom and choice reforms to pensions but what it is fair to say is that interest and awareness of pensions provision has never been higher. Now is not the time to treat tax relief as a form of election piggy bank to dip into to help balance the books. Tinkering with the behaviour of pension savings for a particular set of taxpayers adds even more complexity at a time when the industry is crying out for some stability.
Confusing savers by introducing further changes to the pension taxation system shortly after the most fundamental reforms seen in a generation threatens to undermine public confidence in pension savings by creating uncertainty. The politicisation of pension policy removes the security of outcome that people need in order to place confidence in long term saving for their retirement.
From a financial planning perspective, the one certainty we have at the moment is that further change and reform of pension tax relief is highly likely and savers, especially higher and additional rate tax payers, should maximise pension contributions while they can.
Subject to sufficient earnings, contribution carry forward rules allow you to place up to three tax years’ worth of unused annual allowance into a pension. With annual allowances and tax relief clearly in the main parties’ crosshairs, those in the affected tax bands could do worse than look to place the maximum possible into their defined contribution plans.
Adrian Walker is retirement planning manager at Old Mutual Wealth