Reducing the rate of tax relief on additional rate taxpayers’ pension contributions from 45% to c.30% would save the treasury £7bn annually. And that’s a good thing, right?
The prblem is, as has been pointed out elsewhere, this disincentivises pension saving for additional rate taxpayers. How much is that lost relief really going to cost your clients?
Let’s look at an example: Johnny Taxpayer is 40 and earns £200k per annum; he has just started making £40k annual pension contributions. Let’s have a look at the cost of his contributions with 33%, 30%, or even £25% relief:
| Relief | 45% | 33% | 30% | 25% |
| Johnny pays | £22,000 | £26,800 | £28,000 | £30,000 |
So the cost, to Johnny, of continuing contributions at the same level could potentially increase by up to £8,000. So why continue to contribute?
The Conservative party are not renowned for penalising high earners. Perhaps talk of a flat-rate level of pension tax relief is a precursor to removing other restrictions on higher earners’ pension contributions?
Annual Allowance
Currently pension contributions are restricted to £40,000 per annum, or 100% of earnings. Removing this cap might allow Johnny to achieve the £22k tax relief he had enjoyed in 2015/16, or even more. Here’s how Johnny might benefit from unrestricted contributions (assuming flat-rate relief @ 30%):
| Contribution | £40,000 | £60,000 | £80,000 |
| Tax Relief @ 30% | £12,000 | £18,000 | £24,000 |
| Cost | £28,000 | £42,000 | £56,000 |
But this potentially opens him up to bigger problems down the line, in terms of the Lifetime Allowance…
Lifetime Allowance
Current plans are for the Lifetime Allowance to drop to £1m from April, then to increase with CPI from 2018/19. If the government were to scrap the Lifetime Allowance, what could Johnny’s potential savings be at age 65?
| Years of £40k Contributions | Pension Fund @ 5% growth | Tax relief lost | LTA charge saved (@ 55%) | Overall Tax Saving |
| 10 | £1,176,608 | £60,000 | £97,134 | £37,134 |
| 15 | £1,535,176 | £90,000 | £294,247 | £204,247 |
| 20 | £1,816,124 | £120,000 | £448,868 | £328,868 |
With a lifetime allowance of £1m, individuals are theoretically limited to 25 years of maximum contributions (assuming ZERO growth on fund). HMRC expect individuals entering work now to carry on until they reach age 70, which means up to 54 years in the workplace. And I’m sure these individuals would hope for more than 0% growth on their pension savings!
Surely the government should be encouraging people to provide for themselves in retirement, especially given the acknowledged shortfall in state provision. If flat-rate pension relief becomes reality, I wouldn’t be surprised to see larger changes to pensions for higher earners following in the coming years.
All of the above figures have been calculated using Truth® software. If you would like to know more, please contact 01384 273736.
