Will coronavirus spell the end for higher-rate pension tax relief?

With the government looking to make savings post-virus, pension tax relief may see a shake up.

Tax relief on pension contributions has been compared to a cat with nine lives. Ever since George Osborne was chancellor, there has been recurring talk of some sort of reform to the system. Most recently, there was speculation of changes in the run up to the first Budget with Boris Johnson as prime minister. But to date every chancellor has backed off from actually making any changes.

However, post-coronavirus, with the government looking to make savings, that could change.

To try and keep the economy afloat during the coronavirus lockdown, the government has ramped up government spending. The budget deficit, according to forecasts for the Office of Budget Responsibility, is expected to reach 14% this year, the highest level since the Second World War.

This has raised the prospect of the government engaging in a new round of austerity after the virus. As Steve Webb, partner at LCP, and former pensions minister, notes: “It's fair to say that the government will be looking pretty aggressively at a wide range of potential sources of additional tax revenue.”  

Webb points out that if incomes are depressed, the government may decide instead to explore the option of higher taxes on wealth. As a result, he notes: “Even previously taboo ideas might be considered.” One of these policies could be an end or change to the current pensions tax relief structure, in which higher earners receive 40% tax relief on pension contributions.

Indeed, prominent economist from City University, Richard Murphy, recently called for a package of wealth taxes, including getting rid of the higher-rate tax reliefs for pension contributions, according to a report in The Guardian.  

While previous speculation about changes to pension tax relief has fallen flat, this time may be different. As Webb notes: “This is always in the Treasury's sights, even in the best of times, and especially so if they are looking to those 'with the broadest shoulders' to fund the restoration of the public finances.”

Similarly, Jason Hollands, managing director of Tilney Bestinvest notes: “On each occasion, governments have pulled back from the brink [of changing pension tax relief rules]. Does this mean we can take it that their future is secure? Absolutely not. In my view, the current generous system of pension tax reliefs, where relief is provided at the contributor’s marginal income tax rate, is living on borrowed time.”

Hollands notes that while such changes would likely be unpopular with voters, it could be the opportune time for the government to change the pension tax relief system. He notes: “Pulling these reliefs, which would effectively amount to a significant stealth tax on the middle classes, would undoubtedly be unpopular. However, in the context of the current economic crisis caused by the Covid-19 pandemic and the massive costs being clocked up through fiscal support pledges, the public are conditioned to enduring all sorts of privatisation and need to be braced for both higher taxes and vast increases in public borrowing.”

However, notes Webb: “There are several reasons why they may tread carefully.” He argues that abolishing higher rate relief would be a major structural reform and could take years to properly implement.

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On top of that, such changes would be even more complicated for those in defined benefit pension (DB) schemes. To abolish higher rate tax relief on the roughly six million people with either private and public sector DB pension schemes, “you would have to limit relief on the employer contribution as well (otherwise contributions would just be switched to the employer) and this is especially complex in an unfunded public sector scheme,” say Webb. He points out that some of the losers would be doctors. In the context of the pandemic, this could cause “a huge political backlash”.

Another objection Webb notes is the burden of abolishing higher rate relief on the working age population, furthering perceptions of intergenerational fairness. He notes: “The government will need to avoid the risk that all of the additional tax burden falls on the generation of working age, reinforcing the sense of intergenerational unfairness that many feel at the moment.”

The Social Market Foundation recently called for the triple lock state pension system to be reformed post-coronavirus crisis as a way to raise revenue without placing further burden on the working age population.

Steve Cameron, pensions director at Aegon, however, cautions against premature calls for policy changes. He says: “While the huge increase in government spending will need to be covered in future, it seems premature to be proposing reforming specific government policies on benefits or taxation albeit these may need to be given serious thought in future.

“Crucially, no single policy can be looked at in isolation and we’ll need a much wider ranging review looking at how government policy can help people fairly across the age, income and wealth spectrums, without pitting different groups against each other.”