There are few winners from potential plans to reform pension tax relief, according to analysis from the Pensions and Lifetime Savings Association (PLSA).
The government has widely speculated that it will reform pension tax relief to support the cost of social care and provide more revenue to pay for pandemic support.
The PLSA analysed how various people would be impacted by the four potential reform options. These include setting a flat rate of relief (potentially 20%, 25% or 30%) and TEE whereby pension contributions are taxed as a person’s marginal rate of income but pension income and investment returns are exempt.
The removal of higher rate tax relief would be of little benefit to the majority of basic rate income taxpayers, the PLSA has found, with a single rate of 25% giving only a modest uplift to pension income.
All higher rate taxpayers would pay more tax for every year that they remain a higher rate taxpayer.
For some, particularly those in defined benefit (DB) schemes, there would be very substantial tax bills to pay and, for their schemes, a decision to make as to whether to allow the tax bills to be paid by the scheme in return for lower benefits at retirement.
Under a reform where all the higher rate of tax relief is removed (a 20% single rate), someone who remains a higher rate earner throughout their working life would pay between £34,500 and £205,700 in extra tax over a working lifetime, depending on whether saving into a DC scheme at the 8% minimum AE rate or in a typical DB CARE scheme such as that used in the NHS.
The resulting reduced pension contributions would lead to the high earner’s retirement income falling by between £900 per year and £7,500 per year, depending on the type of scheme. This amounts to a reduction in private pension income of over 20% in all scheme types.
“Our analysis shows that such reforms create few winners and many losers. Under the worst scenario assessed by the PLSA, a person who pays the higher rate of income tax for almost all of their working life could see a reduction of over 20% in their private pension income before tax, irrespective of the type of scheme they belong to,” PLSE director of policy and advocacy Nigel Peaple commented.
“The PLSA estimates that the removal of higher rate tax relief on pension contributions could result in around 3-4 million taxpayers each paying an average of £2,000 more tax each year; money that would otherwise have gone into their pensions.”
As a result of these findings, the organisation is calling upon the government to refrain from further reform and tinkering. “On balance, the PLSA believes the current system of pension taxation should be maintained to encourage an adequate level of saving for all,” added Peaple.
“However, if the government does choose to introduce a reform, we urge them to consider the ‘Five Principles for Pensions Taxation’ that we set out earlier this year, and to consult extensively to avoid unintended consequences.”