Tax raid could cut your pension by £3,000 a year

The abolition of higher rate tax relief for pensions looks increasingly likely. It won't hit super-rich bankers; it's the 'squeezed middle' who will suffer.
I’m worried that the Government will cut income tax relief on pensions in the next Budget. It will hurt people who don’t regard themselves as wealthy and it will also discourage folk from saving for their retirement.
Let’s look at how the system works at the moment. Imagine you’re a higher rate taxpayer earning £50,000 a year. You save £4,000 from your post tax-salary into a pension pot, and you’ll then use that pot to give you an income when you retire.
As things stand, the Government gives you full tax relief on that £4,000 contribution, and so pays an extra £2,666 into your pension pot. In other words, for every 60p saved in a pension by a higher-rate taxpayer, the Government contributes 40p in tax relief to make it up to £1.
If you’re a basic rate taxpayer, the Government only contributes 20p in tax relief to your pension pot.
Now you might think that’s unfair. Why should people who earn more get more tax relief? Shouldn’t everyone only get 20%?
That’s certainly the view of Lib Dem Treasury minister, Danny Alexander. Abolishing higher rate relief would raise £7 billion that could then be used to fund tax cuts at the lower end of the earnings scale.
Bad idea
That sounds appealing when you first hear it, but I’m against this proposal.
My first reason is that there have been enough rule changes already. If you want to encourage people to save for their old age, they need to be clear what the rules are. If pension law keeps changing every two or three years, trust is eroded away. No one can be sure what the Government might do to their pension in future, and this uncertainty adds an unnecessary risk to pension saving.
Secondly, pensions are no longer a massive tax avoidance opportunity for the super-rich. Several regulatory changes in recent years have closed this loophole. The most important change was that people who earn more than £150,000 a year no longer get higher rate tax relief.
So if higher rate relief is now abolished, it won’t affect rich bankers, but it will affect people who earn as little as £43,000 a year.
A lot of people could be affected by this. The Institute of Fiscal Studies reckons that one in four people could be paying 40% tax by 2015.
Fidelity has done some calculations which show how damaging this change could be. Someone who pays £4,000 a year into a pension pot over 20 years could lose out on tax relief worth £56,000. At today’s rates, that’s equivalent to almost £3,000 a year for a couple retiring at 65.*
As Tom Stevenson from Fidelity says: “Someone earning £45,000 would not consider themselves a ‘fat cat’ by any means but they would be caught by this measure and rightly feel aggrieved about the way in which their attempt to make prudent provision for their retirement is viewed by the Government.”
Yes, £7 billion is a lot of money. But it’s also really important that as many people as possible save as much as they can for their retirement. If people don’t save for their old age, the Government will have to foot the bill, and that’s something that future taxpayers can ill afford.
I suspect that George Osborne is far less keen on this idea than the Lib Dems, so let’s just hope he holds firm and doesn’t abolish higher rate relief.
Don’t do it, George!
*This illustration assumes investment growth of 5% a year.
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I thought George Osbourne was the Chancellor. If higher rate tax payers are asked to pay some tax on their contributions it'll be a clear indication that the liberals are running the economy. Then we should all be worried.
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The worst case scenario if higher rate is abolished is that employees will get 20% tax relief on contributions going in and then 40% tax on the pension being taken out. By the time you add expenses, commissions, insurance co profits, etc, most of which are also taxed, the poor old pensioner will have made a thumping great loss. It is only the tax relief which is making pensions worthwhile. If we stopped paying in for pensions, there would be a very much higher bill for Pension Credit in future, which is why tax relief was granted in the first place. Mike
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Looks like Danny Alexander, along with many others, doesn't understand how pensions work. They are not tax free at all. There is tax relief on what goes in. But tax is paid on what comes out. There are only 2 reasons why this might save tax (a) the ability to take a 25% tax-free lump sum at the end and (b) people who get high rate relief at 40% (effectively) when paying in who then pay 20% tax when they draw their pension. Not to say that this will stop him withdrawing the tax relief. Whereafter there wouldn't be a great deal of point making pension contributions if you expect to be a higher rate tax-payer in retirement. In some ways it could be quite a canny (though unfair) move - since pensions are mainly a way of deferring, not saving tax, withdrawing tax relief would be a way of bringing forward the tax paid, by many years. Pretty good for the deficit in the short term.
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17 March 2012