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Higher-rate tax relief could be doomed

John Greenwood
John Greenwood

Anyone who thinks the new limit of a £40,000 annual allowance for higher-rate tax relief on pensions is the end of the road, should think again.

A growing number of influential people argue this is just a staging post on the route to eradicating higher-rate relief.

Abolishing higher-rate relief has been on the LibDem manifesto for some time. The TUC has argued it costs the Treasury more than public sector final-salary pensions, once you take the benefits that pensioners would receive into the equation. Labour stalwarts such as Frank Field and

Patricia Hollis have been pointing the finger at this most expensive of tax reliefs for some time.

No Conservative politician I am aware of has yet called for its abolition but cross-party support took a step closer with the publication in June of a Centre for Policy Studies’ report authored by Michael Johnson, called Simplification is the Key.

The CPS is arguably the think tank with the greatest influence on Conservative policy thinking and Johnson can already claim the £40,000 annual allowance as one of his ideas. In the report, he suggests that as well as limiting tax relief for pension contributions with the annual cap, that tax relief could either be changed to a flat rate, rather than being given at the marginal rate or that, over the longer term, pension savings should be aligned with the Isa regime, with no tax relief up front but growth and income from retirement savings could become exempt.

If George Osborne likes the sound of what Johnson has to say, it will mean massive changes to the way that advice on pensions is given. It could also mean curtains for some parts of the pensions industry.

A flat rate of 20 per cent tax relief across the board would save the Treasury about £7bn a year, every year, a massive contribution to reduction of the deficit, which is the Government’s number one priority. What would the consequences be? The majority of those in company schemes would continue to save because of the employer contribution and the very wealthy, who get most of the higher-rate tax relief, would save elsewhere.

They will never be poor in retirement anyway, so, from a Government point of view, what is to be lost?

Politics, of course, dictates that things are never that simple. Such a change, however appealing – and, in Johnson’s paper, the proposal is sweetened with the quid pro quo of an increase in state pension to take everybody out of means -testing – would make the fuss over capital gains tax look like handbags at dawn.

Cutting the Conservatives’ electoral base’s tax relief in half would not go down well in the shires, or in the press.

Yet Johnson himself puts the chances of higher-rate relief surviving another two years at less than 50 per cent.

If it is not higher-rate tax relief that goes, then the Treasury will surely look again at tax-free cash. Abolition would save around £2.5bn a year – halving it to 12.5 per cent would generate half that figure. These are significant sums when compared with the cuts that government departments are being asked to make over the next few months. If the alternative is having to stop locking up criminals, many voters would argue that curtailing tax relief on pensions is not such a painful cut.

Some have pointed out that such an overhaul, just four years after A-Day, would be nearly impossible because of the complexity involved. That has never stopped them in the past.

If we do head into a double dip, the chances of Osborne having to call on the extraordinary measure of getting rid of higher-rate relief will rise. Even if he does not get rid, there is nothing to stop him from chipping away at the £40,000 limit.

John Greenwood is editor of Corporate Adviser

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. This would just encourage all pension contributions to be made by salary sacrifice so the Government would lose a huge amount of N.I. contributions instead.

  2. David Trenner - Intelligent Pensions 23rd August 2010 at 10:39 am

    Alan

    This is what I said before last year’s budget, but then they came up with the idea of taxing employer contributions.

  3. Yes but surely employees would still get thebasic tax relief plus the NI saving?

  4. I would have thought that any government wanting to stop higher rate tax relief would also simple bar any employer contribution from used to reduce NI.

    Personally I can see no justification for higher rate relief on pension contributions and would prefer to see to money given to the few used to lower income tax for all.

  5. Short term thinking. People who currently receive higher rate tax relief will look at other ways of saving for retirement where the income isnt taxed e.g. offshore bonds.

    But as an higher rate tax payer you cant have it all ways i.e. you cant cry out for more flexibility on how you receive pension benefits (as a way to avoid income tax on pension income) and still expect higher rate tax relief on the way in. Quid pro quo I believe the saying goes.

    However the constant tinkering with pensions does not encourage people to save. Unfortunately the ones who are discouraged are usually those who wont be affected by changes to the amount of tax relief given on contributions.

  6. But even if HRR goes would a rate of 20% encourage people to save?

    Could we not devise a way of coming up with one universal rate of tax relief set at, say, 25%.

    I can’t see 20% relief encouraging many lower paid to invest in a pension plan. As some people rightly say this is just tax deferral as many will end up paying 20% tax at retirement anyway (less the lump sum they take)

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