Hiking pensions tax will harm consumers, experts warn

Pensioners undersave already, so the Treasury is urged not to make Budget raids on retirement pots.

Using pension savers as a tax piggy bank will make them save less towards retirement and not help the lowest earners, a campaign group has warned.

Next week, Chancellor Rishi Sunak will stand up in the House of Commons to deliver his Spring Budget, with fears he will look for ways to try to claw back some of the £289 billion spent fighting the economic battle against Covid-19.

Cutting pension tax relief is regularly mooted as a potential source of revenue for the Exchequer. But the Pensions and Lifetime Savings Association (PLSA) has pointed out how tweaking the incentives to save for retirement, when most people are already undersaving, will leave pensioners worse off.

Moving to a tax-exempt model, TEE – where pension contributions are taxed at a person’s marginal rate of income tax but investment returns and pension income are exempt – would be particularly harmful, according to the PLSA.

It would result in lower pension saving for all income groups, less money for the Exchequer in the future as society ages and remove the incentive for people to lock away their money until later life.

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The current tax treatment for pensions in the UK is described as EET: exempt on contributions, exempt on investment returns and taxed when taken at retirement – apart from 25% which is tax free. 

Removal of higher-rate tax relief has also been suggested. The PLSA calculated that it might save the Exchequer between £8 billion and £10 billion per year. But it would not improve pensions for people who pay the basic rate of income tax, as it would involve no change for them. 

Brewin Dolphin, a wealth manager, calculated under a 25% flat rate relief basis a basic rate taxpayer making a £1,920 net contribution would receive an extra 5% at source, so their gross contribution would increase to £2,559.96. 

Conversely a higher-rate taxpayer would receive the higher gross contribution of £2,559.96. They would then lose the ability to reclaim a further £480 pounds via their tax return and would be £320.04 worse off each year.

The PLSA estimated three to four million higher-rate taxpayers (those earning £50,000 or more) may have to pay up to £2,000 or more in tax per year.

Introducing a flat rate of tax relief for all savers of 25% or 30%, it found, could mean savers in a defined contribution pension scheme would see their income at retirement rate increase by 1 to 2%.

But it would “result in much higher costs for employers and schemes, likely in total to amount to millions of pounds”, it added, would also take at least two or three years to implement, and some experts believe it would result in the end of defined benefit provision in the private sector.

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Nigel Peaple, director of policy and advocacy at the PLSA, said: “More, not less, pension saving is needed so everyone will have an adequate income in retirement.

“Introducing major change to the system of fiscal support for pensions risks undermining hard-won confidence in pensions. This, in turn, could undermine the gains made in recent years, particularly through the advent of automatic enrolment and improvements in governance.”