Autumn Statement: Don't raid pensions, George

There's been a lot of speculation that the Chancellor George Osborne will cut tax relief on pensions in tomorrow's Autumn Statement. That would be a mistake.

Read what was announced in Autumn Statement 2012: what it means for you

We’ve been down this road before. Back in February I feared that the Chancellor would cut pension tax relief in March’s budget, following frenzied speculation that he'd set his sights on our retirement cash. Thankfully in the end nothing happened.

In the last few weeks, we’ve once again seen lots of speculation that a cut in relief will be announced tomorrow. The speculation is so widespread, I fear it’s true. However, I very much hope that I’m wrong.

Higher rate relief

The Chancellor could cut tax relief in two ways. Firstly, he could abolish higher rate tax relief on pension contributions.

Let’s say 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 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 into 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. So if you contributed £4,000, the Government would only add £1,000 to your contribution.

Osborne may change the rules so that all pension savers receive tax relief at 20% on pension contributions. Abolishing higher rate relief could raise around £7 billion a year for the Government.

Tax-free allowance

Osborne’s second possible cut would be to reduce the tax-free allowance for pension contributions.

As things stand, any worker can save his whole year’s earnings into a pension tax-free, up to a maximum of £50,000. If an employer contributes to a worker’s pension pot, the total contributions from both the employer and employee can’t exceed the annual allowance.

However, there’s speculation that Osborne may cut the annual pension allowance to £40,000 or even £30,000. Cutting the allowance to £30,000 could raise around £1.8 billion a year for the Government.

What’s wrong with these cuts?

Now you might think that these cuts seem reasonable. After all, they’re only likely to affect higher rate taxpayers earning a lot more than the average UK wage.

But I disagree.

My main beef is that the annual allowance has already been cut in this Parliament and I think any further cuts would only create an impression that the rules on pension saving change every couple of years.

If you want to get as many people as possible to save for their retirement, you need to have stable, trusted regulation. If you’re worrying every year that the tax rules on pensions will change, you may decide that saving into a pension just isn’t worth the worry and the hassle.

And that would be a great shame. We need everyone to contribute significant amounts of money into their pensions and that applies to people on higher incomes as well as poorer folk.

It’s also worth noting that a cut in the annual allowance could affect some public sector employees who don’t consider themselves rich – such as head teachers and senior doctors.

Most public sector workers are in defined benefit or final salary schemes where they’ll get a pension based on the size of their salary when they worked.

Now if you’re in a defined benefit scheme and you get a promotion, the value of your pension may rise dramatically in that year. That one-off rise in value could easily be larger than £30,000 and trigger a one-off tax bill if the annual allowance was £30,000. This change could potentially affect anyone in a defined benefit scheme who gets a promotion and currently earns more than £40,000 a year.

What would I do instead?

Don’t get me wrong. I think it’s important that richer people pay more tax. I just don’t think that cutting pension relief is the best way to do it. My preference would be for a mansion tax. It’s a difficult tax to avoid and it may also help to reduce property prices.

I realise that Osborne has already ruled out a mansion tax this week, but he hasn’t ruled out anything when it comes to pensions.

However, cutting pension relief would be short-sighted. If people don’t save for their retirement, future governments will have to support more elderly people who have no other source of income. But if a government encourages people to save, more retirees will be able to look after themselves. Isn’t that a traditional Conservative principle?

More on pensions and tax:
New pensions code to boost your retirement pot
Workplace pensions: what it means for you
How to copy Starbucks and pay no tax