Pension tax relief cuts would be another bad intergenerational deal

Should pension tax relief be hacked back to a flat 20 per cent?

Despite the near annual pre-Budget debate, this year’s ‘pension tax relief for the chop’ rumours have come as something of a surprise.

A swipe at higher earners and those who aspire to one day join their ranks, is not quite what you’d expect from a big majority, free spending, freshly-elected Tory government.

Why would Sajid Javid consider cutting pension tax relief? To save money it seems

This is a move more likely to come from the playbook of the Corbynistas or austerity acolytes.

So, why would Chancellor Sajid Javid be considering this (if he really is)?

To save money, it would seem, as the idea flagged in this year’s set of whispers is simply to drag everybody down to basic rate pension tax relief.

This adds 25 per cent automatically to pension contributions, taking people back to the position they were in before 20 per cent basic rate income tax was paid.

Going to that basic level for everyone stands in contrast to the other version of this argument from proponents of tinkering with pension tax relief, which involves a new flat rate somewhere in the middle.

Adding 33 per cent is the generally favoured one, which is easily explained as giving you a £1 top-up for every £2 paid-in.

The case put forward for cutting pension tax relief for 40 per cent taxpayers is that a disproportionate £10billion of the £40billion cost benefits them, as they are a relatively small chunk of the tax-paying population.

This conveniently ignores how that merely reflects the scenario where a relatively small cohort pay a disproportionate chunk of the country’s tax receipts

The IFS says that the top 10% of earners pay 61% of income tax - as this chart shows

The IFS says that the top 10% of earners pay 61% of income tax – as this chart shows

Figures from the Institute of Fiscal Studies show that the top 10 per cent of income taxpayers have incomes above £59,000 and contribute 61 per cent of income tax receipts.

As you go up the scale of earners, this effect becomes even more pronounced, but so too does the quite severe scaling back of the value of saving into a pension. 

Kicking in at various points are the £40,000 annual allowance, its tapering down to £10,000 for earners above £150,000, and the £1.05m lifetime limit that equates to an annual pension income of less than £40,000.

While very pertinent to the debate, this is not the reason why I am against a raid on pension tax relief, however.

Instead, I think there are two very good reasons to avoid it:

Firstly, tax-free pension saving isn’t a perk – as it is often described – it’s a long-standing principle, which can be traced back to the Finance Act of 1921.

Just because something has been around a long time doesn’t mean you shouldn’t change it, but I’d argue it does mean it’s wise to think very carefully about breaking such a link.

The beauty of the system is that everyone is treated equally. Whatever the rate of tax that you pay, you get to save into a pension free of it.

Obviously, the more tax you pay the greater the benefit that amounts to on the next £1 you earn being paid into a pension, but that’s how maths works – and you have already paid more tax than someone further down the scale by the time you get to pay that pound in.

Once you revise tax-free pension saving, so that it’s no longer the same deal whatever your rate of tax, you greatly increase the risk that in future it starts to be hacked further back. 

What arbitrary number could a future Chancellor citing hard times come up with? 

What arbitrary number could a future Chancellor citing hard times come up with?

Would we see it drop below basic rate tax relief? Perhaps we’d get 15 per cent or 10 per cent for all – and then maybe it would be removed altogether.

Wouldn’t happen? 

Remember the lifetime allowance started at £1.5million in 2006 and climbed to £1.8million by 2011, before being slashed all the way down to £1million by 2016. It’s barely edged up to £1,055,000 now, despite being widely considered a bad policy.

As long as the tax-free pension saving principle remains enshrined in the system, it is less likely the rate gets whittled down.

My second reason for not backing a change is that this is another prime example of intergenerational unfairness.

Moves such as cutting higher rate tax relief are often depicted as hitting the wealthy older generation, but that’s disingenuous.

Those in the 50s and 60s have spent a working lifetime getting higher rate tax relief and far superior final salary pensions. 

The people this really affects is the younger generation of 40 per cent taxpayers, or those who aspire to one day earn £50,000 and fall into that bracket.

Those in the 50s and 60s have spent a working lifetime getting higher rate tax relief and largely benefitting from far superior final salary, or other forms of, defined benefit pensions.

The generations below (vested interest alert – this includes me) are lumbered with inferior defined contribution pensions, where they must save much harder to get a lower non-guaranteed income in retirement.

On top of that they would then see the tax-friendly pension benefits the older generations enjoyed removed.

There are plenty who disagree with my view that things shouldn’t be changed, but any conversation about cutting pension tax relief needs to be honest about this intergenerational issue that mainly gets swept under the carpet.

And if the government is going to change things, it should follow its own slogan and level up not down.

Keep full pension tax relief for higher earners, but also give basic rate taxpayers more pension tax relief – perhaps that 33 per cent – to put them closer to reclaiming their real 32 per cent tax rate when you add income tax and national insurance rates together.

Yes, this would cost money, but it is cash that would go into boosting people’s pensions – and we’re going to need those in years to come.


Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.

Source link