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Question of cashflow

Alistair Darling’s admission to the Treasury select committee that there was “no science” employed in arriving at the new top rate of tax for salaries over £150,000 seems incredulous.

But then when you look at the proposals for limiting higher-rate tax relief on pension contributions, it becomes apparent that not applying a rational approach is perhaps all too common.

What has been proposed breaks the principles on which our pension system is based.

One principle is that a pension is a deferral of income. You can make a choice. Receive earned income, which is taxed immediately, and spend the remainder how you wish or defer receiving income by locking it inside a pension plan. This requires you to draw an income in the future, at which point it will be taxed as earned income.

In the same way, HMRC is not “giving’ tax relief on pension contributions but simply deferring taking tax. And when tax is applied, it is not just on the capital element of the retirement income but the growth that has been accumulated. The all-important and essential sweetener for locking your money away is the 25 per cent pension commencement lump sum that can be taken out free of tax.

Some will argue that those who get higher-rate tax relief on contributions will be basic-rate taxpayers in retirement so HMRC will not fully recoup the deferred tax. I wait to be convinced that it is more than a minority who manufacture this situation and in doing so seriously dent the Exchequer’s balance sheet.

The real issue for the Treasury is not the giving of higher-rate tax relief on contributions, it is about cashflow. They state that 25 per cent of pension tax relief granted has benefited those who earn £150,000 or more who represent 1.5 per cent of those saving in a pension. Or, put another way, the highest earning 1.5 per cent of pension savers have deferred taking income and thus denied the current Government some immediate income tax revenue. Instead, they will be paying income tax to some future Chancellor when they eventually take their retirement income. That is what the Government does not like.

What is more, this skewing of tax relief being granted to high earners has chiefly occurred since the introduction by the current Government of the pension simplification regime three years ago on April 6, 2006.

Pension simplification swept away decades of complicated pension legislation and introduced a relatively simple rule that meant that anyone could build up a pension fund through tax-relievable contributions of up to the lifetime allowance, originally set at £1.5m, this being the ultimate limit on the accrual of the income you could defer for taxation at a later date.

However, tax relievable contributions paid in any year are limited to the lesser of 100 per cent of earnings or the annual allowance, originally set at £215,000.

Surely the simple solution is to reduce the annual allowance to, say, £150,000 or perhaps some scientifically calculated figure that would do the job of easing the current cashflow problems.

David Seaton is joint managing director at Rowanmoor Pensions

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