In a recent proposal presented by Treasury officials, the Chancellor, Rachel Reeves, is being urged to consider a flat 30% rate of pension tax relief. This would mean that higher rate taxpayers would pay an effective 10% tax charge on their retirement contributions for the first time, affecting up to 6 million individuals.
Pension contributions are currently tax deductible, with basic rate payers receiving relief equal to 20% of their payments, while higher rate payers get relief of 40% and additional rate payers get relief of 45%. These rules cost the Exchequer more than £50 billion each year, encompassing income tax relief, corporation tax relief, zero tax on pension growth, and the exemption of National Insurance on employer pension contributions.
The Treasury has long been interested in taxing pension savings and has explored various proposals, including flat rates of 20% and 30%. A 30% rate is considered more politically acceptable as it could be seen as a beneficial measure for basic rate taxpayers, while higher and additional rate payers could face charges of 10% or 15%.
Implementing a 30% flat rate would result in an estimated £2.7 billion increase in tax, according to the Institute for Fiscal Studies (IFS). This policy would save the bottom 80% of earners around £230 per year, while the top 10% could see an average tax increase of nearly £2,600 annually.
Moving to a flat 30% tax relief rate could potentially “level up” the savings landscape, offering significant support to the majority of workers who stand to benefit financially. However, experts have raised concerns about the impact of such a change on salary sacrifice pension schemes, which provide a tax-efficient way for employers and employees to contribute to workplace pensions.
While these proposals are still under consideration, the potential ramifications of changing the current pension tax relief system are vast. It is essential to weigh the benefits and drawbacks carefully to ensure that any alterations do not discourage individuals from saving for retirement.
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