What would 30% flat fee pension tax aid imply for YOUR financial savings?

Pension tax relief rebates any tax you would have paid on your contributions into your pot, to put you back where you started.

The present system is tilted in favour of the better off because they pay more tax.

Speculation that Chancellor Rachel Reeves will consider a pension tax overhaul – including a flat rate – has prompted warnings of a potential hit to six million higher earners’ pensions.

Other downsides being aired are the impact on economic growth if they invested less, a clash with salary sacrifice contributions, and complications with  final salary pensions – which could even spark public sector strikes.

Tom Selby, director of public policy at AJ Bell, explains whether a shake-up is likely under Labour and how it might affect pension savers.

The potential for a raid on retirement savings incentives is a rumour that usually does the rounds before a Budget.

As things stand, contributions to pensions benefit from tax relief at your ‘marginal rate’, meaning basic rate taxpayers get 20 per cent, higher-rate taxpayers 40 per cent and additional-rate taxpayers 45 per cent.

To limit the cost of tax relief to the Exchequer, most people have an annual allowance of £60,000, although those who have flexibly accessed their pension and very high earners have a lower allowance.

In addition, there are limits on the lump sums people can pass on from their pensions to their nominated beneficiaries when they die.

The most common pre-Budget pension tax relief speculation centres around the future of higher-rate pension relief and the potential to introduce a flat rate of pension tax relief.

At the more extreme end, this measure could see pension tax relief restricted to the basic rate of 20 per cent for all, with advocates suggesting this could raise billions of pounds of extra revenue for the Treasury.

However, as with most radical pension tax changes, introducing a flat rate of relief is much easier said than done.

A huge chunk of any potential savings to the Treasury from a pension tax relief raid would come from defined benefit schemes, the majority of which now reside in the public sector.

If a flat rate of pension tax relief below 40 per cent were applied on these schemes, the only way to ensure the correct level of tax relief was applied to contributions from higher and additional-rate taxpayers would be to hit those members with a tax charge likely running into thousands of pounds.

This would therefore risk opening up a blistering row with NHS staff and civil servants at a time when many public services are already stretched to breaking point.

Reducing the upfront incentive for people to save in a pension would also run counter to wider government efforts to boost long-term investing and risk undermining the flagship automatic enrolment reforms.

In addition, younger people who are less likely to have benefitted from higher-rate tax relief may feel understandably aggrieved that a benefit offered to the previous generation has been ripped away from them.

Having ruled out reintroducing the pension lifetime allowance, there remains the possibility that the annual allowance could be tinkered with to raise some much-needed cash.

But again, this would sit uncomfortably with the broader investing agenda and rub up against this government’s overarching mission of delivering stability.

How would a 30% flat rate affect what people save into pensions? 

These are both the same example, just slightly different ways of getting to the answer.

Net pay scheme

If a higher-rate taxpayer pays a £1,000 contribution at the moment, they automatically get 40 per cent tax relief.

In other words, they don’t pay £400 of income tax they otherwise would.

If a flat rate of tax relief at 30 per cent is introduced, they would need to pay £100 tax to reduce their tax relief to 30 per cent.

So, their £1,000 contribution has now ‘cost’ them £700 rather than £600).

On the other side of the equation, a basic-rate taxpayer would presumably need to be handed an extra £100 in tax relief, possibly through a £100 reduction in the overall tax they pay.

So, their contribution has now ‘cost’ them £700 rather than £800).

Relief at source scheme

In a relief at source scheme, if we assume the tax system is adapted to add the full 30 per cent tax relief on automatically (rather than the person having to make a claim to HMRC), then a £700 upfront contribution would be grossed up to £1,000 via tax relief.

In other words, they get £300 of tax relief – 30 per cent of £1,000.

What if you have a Self-Invested Personal Pension scheme (Sipp)?

It is slightly tricky modelling over time as when you consider a higher-rate taxpayer contributing to a Sipp, they currently get 20 per cent relief automatically and then claim back the extra 20 per cent.

If it was moved to 30 per cent then they might still get 20 per cent upfront going into the pension (depending on how the system works) but then just claim back the extra 10 per cent. 

So the impact would just be they can reclaim a bit less tax than currently.