How would possibly flat charge tax pension reduction have an effect on wage sacrifice?

How would a flat rate pension relief work with a salary sacrifice workplace pension?

I am trying to plan for what may happen. I always like to do some pre-calculations so that if change does come I can quickly make plans to alter, in this case, my pension contributions.

If Labour were to introduce a flat rate pension tax relief how would this work for me where my pension comes out of my salary pre-tax?

I can get my head around 30 per cent as a flat rate if I were investing into a self-invested personal pension (Sipp). But as a gross payment how would this work and what tax would be left to pay on my salary?

I currently put £60,000 in my pension each year. The new higher maximum has really helped me catch up due to neglecting my pension for years.

Tanya Jefferies, of This is Money, replies: Labour has said nothing so far to suggest it plans to reform pension tax relief.

However, it intends to carry out a ‘review of the pensions landscape‘ to consider steps needed to improve pension outcomes and increase investment in UK markets.

This has prompted speculation that it will also look at the feasibility of radical reforms to pension tax relief. 

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

This important top-up to pension pots is based on people’s income tax rates of 20 per cent, 40 per cent or 45 per cent, which tilts the system in favour of the better-off because they pay more tax.

Changes would cause problems with final salary and other defined benefit schemes, and clash with salary sacrifice contributions.

The other downsides commentators have already aired in the press include the potential hit to six million higher earners’ pensions, the impact on economic growth if they invested less as a result, and serious complications with public sector pensions – which could even spark another wave of strikes.

We asked a finance expert to explain how a flat rate of pension tax relief for everyone would work, and what – if anything – pension savers can do to plan ahead for such an overhaul.

Ian Cook, chartered financial planner at Quilter Cheviot, replies: The possibility of a flat rate pension tax relief is a complex topic, and its implementation would be even more complex.

It is important to note that making decisions based on speculation is not advisable. It’s always best to plan your finances based on the current rules and your specific financial situation rather than ‘ifs and maybes’.

However, I will detail some of the points it is worth bearing in mind if this is something you are thinking about.

What is flat rate pension tax relief?

Flat rate pension relief means that everyone gets the same percentage of tax relief on their pension contributions, regardless of their income tax bracket.

For instance, if a flat rate of 30 per cent were introduced, all pension contributions would receive this level of relief, rather than the current system where relief corresponds to your marginal tax rate (20 per cent, 40 per cent, or 45 per cent).

This would fundamentally change the way tax relief is applied to pension savings and as such require huge wholesale change to the pension taxation landscape.

How does salary sacrifice work?

Salary sacrifice is a popular scheme where you agree to reduce your salary in exchange for your employer making equivalent pension contributions.

This is tax-efficient because it reduces your taxable income, therefore lowering the amount of income tax and National Insurance you pay.

How might flat rate tax relief affect salary sacrifice?

Here’s how it might work under a flat rate system.

If you currently sacrifice £60,000 of your salary into your pension, that entire amount is contributed pre-tax.

As a higher-rate taxpayer, you effectively get 40 per cent tax relief on those contributions.

If a 30 per cent flat rate is introduced, the mechanics of salary sacrifice would need adjustments.

Under the new system, your £60,000 contribution would still reduce your taxable income, but the tax relief you’d get might differ depending on implementation details.

To make flat rate relief work, all pension contributions, including employer ones, would need to be standardised.

This might require substantial changes to the current system where contributions are deducted pre-tax.

For example, employers might need to adjust their payroll systems to ensure that the correct amount of tax relief is applied.

If the flat rate relief is implemented, your contributions will still be made before tax, but the amount of tax relief you receive might be recalculated based on the new flat rate.

How much notice would savers get to plan ahead?

Given the complexity of such changes, it’s likely there would be a considerable period of consultation and phased implementation, possibly over a period of years rather than weeks or months.

This would provide time to adjust your financial planning accordingly.

While it’s prudent to be aware of potential changes, making any knee jerk decisions without the detail is always highly inadvisable.

For the time being, I suggest you continue to make pension contributions based on the current rules, as pensions remain a highly tax-efficient way to save for retirement.

As you mention you are making good use of the changed annual allowance rules to make up for missed years of pension contributions, and you are correct to just play the policy hand you are dealt at any one time.

Moreover, it’s important to understand that any significant changes to pension tax relief would likely come with transitional measures to ensure that individuals and employers have adequate time to adapt.

For instance, there might be provisions to ‘grandfather’ existing contributions under the old rules or to phase in new rules gradually to mitigate any immediate financial impact.

Planning based on current regulations and seeking professional advice will ensure that you are prepared for any future changes.

How should savers deal with the ‘rumour mill’ about Labour changes to pensions?

While it’s understandable that a new Government will get the rumour mill going and changes to the pension landscape can be worrying, these types of rumours should not be acted upon.

Significant changes would come with ample notice and transitional measures.

Staying informed, seeking personalised advice, and planning based on the current rules will help ensure that you are well-prepared for any adjustments to pension taxation.