Lots of taxpayers are missing out on the correct tax relief, but this switch could fix the problem.
Higher‒ and additional rate taxpayers could enjoy a boost to the size of their pension pots following proposals from the Office of Tax Simplification (OTS).
Last week the OTS ‒ which was set up by the Government a decade ago to identify ways in which we can ensure that our taxation regime in the UK is a little less… well, taxing ‒ published a consultation into the use of third party data to HM Revenue & Customs (HMRC).
I know what you’re thinking; that sure is a sexy topic for a consultation. But if the suggestions from the OTS come to pass, then greater use of this data will mean bigger pension pots for those who pay higher rates of Income Tax.
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The problem with tax relief
Saving into a pension is a good idea if you fancy having some comfort in your later years, obviously, but it’s also a pretty tax-efficient way to save money too.
That’s because the cash you put into your pot gets topped up the Government in the form of tax relief.
The exact amount you qualify for is dictated by your Income Tax band.
So if you’re a basic rate taxpayer, paying 20% tax, then your contributions are topped up by 20%, meaning that the £1 you put in becomes £1.25.
That relief is even greater if you pay the higher or additional rate of Income Tax, making pension contributions even more tax efficient.
There is a hitch though. When you pay into your scheme, only the basic rate of relief is added. It’s then up to those people who pay a higher rate of Income Tax to manually claim the rest of what they are owed through their tax returns.
And all too often this doesn’t actually happen,
As the OTS puts it: “Many people who are eligible to claim relief from higher rates of tax for charitable donations or pension contributions, do not currently do so.”
It’s good to talk
That’s where this consultation comes in, with the idea of taking responsibility away from individual taxpayers and instead ensuring that data is shared properly between pension firms and HMRC on the taxpayers’ behalf.
So for example, if I have a particularly good year and find myself in a higher Income Tax bracket, the details of my pension contributions ‒ and therefore the tax relief I’m due ‒ will come from Hargreaves Lansdown, with whom I have a SIPP.
By leaning on data more, the idea is that a greater number of people will enjoy the tax relief that they are entitled to, which is obviously as it should be.
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How do we pay for it?
It’s time we address the elephant in the room. Greater sharing of data would mean more people get the right tax relief, which in turn means that it would cost the Government more money.
This isn’t small change we’re talking about either ‒ Sir Steve Webb, the former pensions minister who is now a partner at consultancy LCP, warned that this would mean the Government having to find millions more each year.
He added: “It is to be hoped that the Government will not block an idea which would make life simpler for taxpayers and give them the reliefs which they may currently miss out on.”
Webb isn’t wrong, but equally given the current economic difficulties and the constant noise from the Treasury about having to pay for the various Covid-19 support schemes sooner rather than later, it remains a big question whether the Government will actually follow the OTS’s lead on this.
Ripe for reform
The consultation runs until 9th April, but even if it leads to firm proposals from the OTS on how it could work, the Government isn’t actually obliged to follow them.
However, it’s worth remembering that pension tax relief has been an area that the Government has been looking at reforming for years now.
This has often centred on the potential introduction of a single rate of tax relief, rather than the current system where higher earners get an additional helping hand from the Government at the expense of basic rate taxpayers.
We’ve highlighted before how tax relief could be improved, and with the Budget almost upon us, it will be interesting to see if 2021 is finally the year in which the Treasury acts.