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Light relief

The Budget introduced some significant changes to the tax relief available on pension contributions. When you consider the current levels of Government borrowing, estimated to be £528bn over the next five years, it could be argued that the Government needs to take more drastic action and further reduce higher-rate tax relief available on pension contributions. Higher-rate taxpayers should consider urgently their pension contributions and the opportunities available.

The Budget report stated: “Those on highest incomes benefit disproportionately” from pension tax relief.

In total, tax relief on pension contributions cost the Government £29.3bn in 2007/8, with a quarter going to the top 1.5 per cent of savers.

According to Government figures, 63 per cent of tax relief on employee and individual contributions went to higher-rate taxpayers.

Currently, the Government estimates an increase in revenue of just £3.1bn by restricting higher-rate tax relief on pension contributions for people with income of more than £150,000. This represents only 11 per cent of the total tax relief given to pension contributions.

The current change to tax relief on pensions will affect around 291,000 people. However, there are a further 3.3 million people who are higher-rate taxpayers but who earn less than £150,000 and these could be caught if further restrictions were introduced.

People earning between £44,000 and £150,000 are currently in the sweet spot for making pension contributions.

Tax relief on pension contributions made by salary sacrifice or as personal contributions to an occupational scheme will be at least 40 per cent for these people. For those with an income of between £100,000 and £112,950, tax relief could be 60 per cent.

Consider someone with an income of £110,000 whose personal allowance will erode to £1,475, leaving a taxable income of £108,525.

They will pay tax at 20 per cent on £37,400 and at 40 per cent on the balance, resulting in a total tax bill of £35,930.

Making a personal contribution of £10,000 to a pension scheme via salary sacrifice will reduce their taxable income to £100,000, making them eligible for their full personal allowance of £6,475 and providing a taxable income of £93,525.

They will pay tax at 20 per cent on the first £37,400 and at 40 per cent on the balance, resulting in a total tax bill of £29,930.

This means they will pay £6,000 less tax by making a £10,000 pension contribution, an effective rate of tax relief of 60 per cent.

These are additional opportunities to provide advice in this area. For example, under Budget proposals, clients with relevant income of more than £150,000 have a special annual allowance of £20,000 for pension contributions.

They will receive 40 per cent tax relief on contributions in the current tax year, increasing to 50 per cent up to this level on the special annual allowance contributions paid in the 2010/11 tax year, with any contributions over the allowance receiving tax relief at 20 per cent.

History has demonstrated that when Governments need to raise revenue, reducing or abolishing tax reliefs is a “stealth” option when compared with introducing tax rises.

Given the current Government’s move to restrict higher-rate pension tax relief in the Budget, it is feasible that they could extend this to all higher-rate taxpayers.

Ensuring that clients review their pension contributions and take advantage of the opportunities available could be a wise move.

Colin Jelley is head of tax and financial planning at Skandia


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