The Chancellor’s next budget is only six weeks away, and the jungle drums suggest there could be another bombshell around savings.
Ahead of every budget in the past 20 years, there have been dire warnings that the chancellor is about to attack higher-rate taxpayers by scrapping their right to higher-rate tax relief on pension contributions.
It’s a very good deal – for every £6 you pay in as a marginal 40per cent taxpayer the government effectively adds another £4, whereas for basic rate payers the £6 becomes £7.50.
But it also costs the Treasury – the last financial secretary Danny Alexander claimed the higher rate bonus amounted to £7billion in lost tax. The total given away in pensions tax reliefs is over £35billion, and 70 per cent of it is said to benefit higher-rate payers, who include those on a marginal 45 per cent.
Despite the annual crying wolf, by a pensions industry looking for an annual business boost, this time it’s for real.
George Osborne has already consulted on possible changes to the system. A year ago he floated the idea of an ‘Isa pension’, where tax relief would be scrapped altogether on pension contributions, and applied instead to the final pay-out, like an Isa.
The chancellor has already signalled this is a freedom too far. But a move to a flat rate of tax relief for everyone has long been championed by Baroness Altmann, who is now pensions minister. Her support for what would still be a radical overhaul may be important, especially as the chancellor could present it as the government topping up your long-term saving - a message that gets lost in the intricacies of tax relief.
According to the Association of British Insurers, a single rate of tax relief could be sold as a 'Savers’ Bonus'.
The ABI says: “A flat rate of 25per cent or 33per cent could be presented as a top up of £1 for every £2 or £3 that savers contribute, making savings much more visible and simple to understand for both workers and employers.”
It says either rate would be an improvement on the current 20per cent tax relief for basic rate taxpayers, helping low and middle income earners build up a pension pot. “At the moment, basic rate taxpayers only get £1 for every £4 put in, while higher rate payers get £2 for every £3 put in, but a Savers’ Bonus would top up pensions equally for all savers.”
Yvonne Braun, the ABI’s director of long term savings policy, says: “A Savers’ Bonus is the best option available to government to encourage people to save and ensure they have a pension pot large enough for potentially significant costs during retirement. A single rate of tax relief would be simpler, fairer and more sustainable or all savers.”
Chris Noon at Hymans Robertson argues that the present higher-rate relief should be cut from 40 to 33 per cent, with basic rate relief left at 20 per cent. “Capping income tax relief would be the easiest policy change to implement. Much of the required infrastructure is already in place and the concept can be easily communicated. “
He says a flat rate system could not ensure the desired results. “For example, how will the Government be sure that any top-up to low earners implemented through income taxation will be allocated to pension savings, rather than simply boosting current income?” It could also choke off the savings of higher earners, Mr Noon says. “These are not ‘fat cats’, these are the squeezed middle in terms of pension saving.”
But that might not be so politically attractive to Osborne.
Tom McPhail, head of retirement policy at Hargreaves Lansdown, says: “A move to a flat rate incentive system would almost certainly be accompanied by a wholesale shift across to the other method of tax relief, known as ‘relief at source (RAS)’ whereby an investor makes a contribution net of the tax relief and the pension provider then claims a top-up from the government.”
So under the present regime a payment of £80 would be topped up to £100. A flat rate of 25 per cent would allow the government to trumpet the savers bonus: an investor would pay in £60 to get a government top-up of £20. A 33 per cent flat rate would mean a £60 contribution triggering a £30 top-up – which could even be presented as a 50 per cent bonus.
McPhail notes: “If the Treasury is going to announce a flat rate system for the future, they’d have to bring down the shutters on 16 March, in order to prevent wealthy investors from grabbing any last share of the higher rate relief before it is abolished. If they didn’t do this, we estimate that it could cost the government an extra £6 billion within just a few weeks. Any higher earners who are looking at paying into a pension, should think seriously about doing so before 16 March. Conversely, for basic rate taxpayers, it may make sense to wait until after that date.”
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