Last July, alongside the second Budget of the year, the Treasury announced a consultation on pension tax relief. It seems likely the government considers paying higher rate and additional rate pension tax relief in particular to be expensive. As more individuals have become higher rate and additional rate taxpayers over the past ten years or so, the cost is reckoned to have increased. A look at the figures suggests the increase is only just ahead of inflation (as measured by the Retail Prices Index), but further changes are coming that will continue to increase the costs such as the ongoing implementation of automatic enrolment in pensions for all employees who do not already have an occupation pension over the next few years.
The two main ideas being floated for pension tax relief reform are flat rate relief, and ISA-style pensions.
Under flat rate relief, a single rate of tax relief would apply regardless of whether the individual is a basic, higher or additional rate taxpayer. This would increase the tax relief offered to basic rate taxpayers (who currently pay 20% tax and so receive 20% tax relief) but reduce the amount offered to higher (40%) and additional (45%) rate taxpayers.
In 2013, the Pensions Policy Institute estimated that a flat rate of 30% tax relief might be roughly revenue neutral for the government. The current figure being floated in the press is a flat rate of 25%, which is reckoned to represent a £6bn a year saving to the Exchequer, at least in the short term.
ISA-style pensions would not receive tax relief on contributions but the benefits would be tax-free when paid in retirement. This is known as a ‘taxed-exempt-exempt’ regime, as currently applies to ISAs, rather than the ‘exempt-exempt-taxed’ regime that currently applies for pensions. Moving to the ISA-style regime would effectively bring forward tax from the future, making the government better off now and leaving its successors to deal with the eventual outcome (untaxed benefits). Pension savers would have to trust that future chancellors would not change the rules again to take some tax on benefits, resulting in a taxed-exempt-taxed regime. Right now this seems to be the less favoured option.
We’ll know more about the government’s preferred approach after the Budget on 16 March 2016 but those planning pension contributions who want to be certain to secure higher or additional rate tax relief may wish to act before then.