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Higher rate pension tax relief for the axe after election, warns Webb

Pensions minister Steve Webb says higher rate pension tax relief will be under threat after the election, no matter which party gains power.

 
Higher rate pension tax relief for the axe after election, warns Webb

Higher rate tax relief on pensions is likely to be cut after next year’s election, no matter which party gains power, pensions minister Steve Webb has warned.

The 40% tax relief afforded to higher earners has long been ear-marked for a cut but no politicians have yet to follow through. Everyone who saves into a pension is entitled to tax relief on their contributions which is paid at their highest rate of income tax to encourage everyone to save for retirement.

Higher rate tax relief costs £7 billion a year, and is seen by some as unfair given the greater relief afforded to higher earners than those on the basic rate of tax.

Webb (pictured), who has championed a flat 30% rate of tax relief on pensions for all, said he doesn’t think it is right that ‘if I want to save £1 in a pension it costs me (as a higher rate taxpayer) 60p but someone working in my office, it costs them 80p (because they are a basic rate taxpayer’.

The fact that the tax relief is seen as inequitable, particularly given that many higher rate taxpayers only pay basic rate income tax or no tax at all on pension income, and the need for the next government to continue reducing the deficit, means 40% pension relief could make it to the chopping board.

‘I would be very surprised if the next government leaves [higher rate tax relief] alone,’ said Webb. ‘They will be looking for money…any chancellor will have to look at this pool of money.’

Pension expert Steve Bee, chief executive of Jargonfree Benefits, argued that tax relief was not in fact a relief but a deferral of income tax payment and it would be unfair to cut higher rate relief.

‘You do not get tax relief on pensions. If you put your money aside for decades the deal is you only pay income tax once, that is not a great deal for pensioners,’ he said. ‘The fact that income tax rates change is interesting but not relevant.

‘The tax rate [at the moment] is very low – it was 35% when I started work and when it came down to 33% it was front page news. 20% is very low and a lot of people who [are paying into a pension] and deferring tax may well find the tax rate is 35% again [by the time they retire] – that is the real risk.’

Bee said the technology available today should make it possible to tax each tranche of a pension in retirement at the rate that prevailed at the time it was earned.

Tax-free lump sum

Neil Lovatt, director of Scottish Friendly, argued that the next government will also have to tackle abuse of the tax-free lump sum that has been created by the new pension freedoms.

The 25% tax-free lump sum is available to every retiree from age 55 and Lovatt argued that individuals can use the rules to ‘wash’ money through the system. This is done by putting money into a pension one day, receiving the tax relief from the government on the contribution, and the next day taking out the money with 25% of it tax free.

‘This is an area the government has to look at,’ he said. ‘The tax-free lump sum [rules] allow your to wash through [money] and take taxpayers’ money.’

However, Bee said that restricting or scrapping the tax-free lump sum would have grave consequences for pensions.

‘Without [the tax-free lump sum] you would be crazy to put your money in a pension,’ he said.

23 comments so far. Why not have your say?

Clive B

Dec 24, 2014 at 10:18

Webb ..said he doesn’t think it is right that ‘if I want to save £1 in a pension it costs me (as a higher rate taxpayer) 60p but someone working in my office, it costs them 80p (because they are a basic rate taxpayer’.

Seems 'fair' (I hate that word) to me, as in both cases the person had to have earned £1 gross. Surely the whole principle of paying into a pension is that you don't pay tax on it (well, you do, but you get it back)

With a 30% flat rate, we'll be paying a benefit to basic rate tax payers (oops, there goes getting the deficit under control) while higher rate tax payers will probably find other things to do with their money. Once, again government's figures will be scuppered by their obsession to make things 'fair'

p.s. I have no axe to grind on this, as I don't have a pension in my current job

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In the Dark

Dec 24, 2014 at 10:53

May be, what is not fair is the 40% tax in the first place. Furthermore, the higher rate tax relief costs £7 billion per year, excuse me, I think you forget who's money that is under discussion.

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Keith Cobby

Dec 24, 2014 at 11:32

Agree with In the Dark. A flat rate income tax (incl NI) for all.

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Spartacus

Dec 24, 2014 at 13:10

The higher rate of tax is not only too high at 40%, it comes in at a fairly modest income level - at my workplace, twenty years the only colleague to be on higher rate tax was our managers manager - now we all seem to be in its clutches.

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Briesmith

Dec 24, 2014 at 14:45

It's not tax free saving, the government isn't losing anything nor is it adding anything to pension contributions through the current tax treatment of pension contributions.

All that's happening is that to encourage pension take-up the government says, "if you defer your income today and take it in future years as a pension we will similarly defer your income tax today to charge it when you eventually take the deferred income as a pension."

Without this deferral, giving up your income to put it into the hands of government would make no sense. It would be simple madness to trust the government, any government, to behave honourably if there was nothing to be gained by doing so.

Remember, although during your life you may have been a standard rate payer while paying pension contributions, or even no tax, when you come to take your pension, you will pay tax on your pension income at your current rate.

If you have gone on in your career to do rather well and have been able to build a sizeable pension, one that takes you into the 40% or 45% tax bracket, you will pay 40% or 45% on those contributions you originally only received 20% or no tax deferral on.

That is the inherent gamble built into the pension system in the UK.

If the government takes away the higher rate income tax deferral, pensions for higher earners will cease to have any purpose.

ISAs and other tax sheltering schemes - buying as big a house as you can possibly manage etc - will be far better options.

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andy

Dec 24, 2014 at 16:20

Since when has the words "tax" and "fair" come in to the same sentence. Its not "fair" that people earning £100k pay 60% tax and those that earn £130k pay 40%.

The government seems to be under the delusion all money is theirs and its not fair that the "subsidise" peoples pensions. As stated before - it's not their money - it's ours - and we are subsidising them as if they hadn't been so profligate and wasteful we would be able to have decent pensions for all - now we have to subsidise the to the tune of 60% or 80% of our pension contributions.

As I stated before - this is the same as the tax avoidance / evasion deliberate blurring by disingenuous politicians.

Why can't they just be honest - we might not like it but we might respect it them a bit more.

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Clive B

Dec 24, 2014 at 17:03

andy

I suspect that in popular parlance a 'fair' tax means one that only other people pay, but not those who view it as being 'fair'.

Agree with your point about blurring of terms.

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David 111

Dec 24, 2014 at 17:23

Briesmith - I find it difficult to construct a scenario whereby someone pays income tax at 0% or 20% for most of their working life, but somehow manages to end up with a pension putting them in the 40% tax bracket. If you know how to do this, perhaps you could share your knowledge, as I'm sure many of us would like to achieve this.

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Briesmith

Dec 24, 2014 at 17:32

Given an employer which values an employee's output at £20 per hour then the total annual employment cost is £38,732.07 based on a working week of 37.5 hours. This is the amount the employer is prepared to pay to employ that employee.

And given 12 salary months in the year, the employee should see on his payslip a salary each month of £3,227.67 but will, in fact, see £2,229.56 after suffering a tax charge of £1,000, give or take a pound or two.

This is the "fair" tax system we have in this country based as it is on extortionate rates - pretty much 33% - and on dishonesty.

The first lie is that the standard rate of income tax is 20%. As the calculation shows, it's nowhere near that and is much closer to 33%.

The second lie is that the employee's "gross" salary is, in fact, £35,000 pa and not nearly £4,000 a year more because, somehow, "employer's" NIC is paid by someone else, not the employee.

The third is that NIC isn't income tax when it plainly and absolutely is.

If you were to keep your P60s for your working career and add up all the years you'd paid a third of your income in tax and ask yourself what better use you could have made of it, how much better off you'd be if you kept some of it, how much more you could have done for your family, and could do now, you'll weep.

Fairness doesn't even come close.

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Briesmith

Dec 24, 2014 at 17:45

@ David 111

Never mentioned "most of their working life".

Very easy to envisage a 40 or 50 year career where someone earns at a low rate for the first 10 years or so then moves up the career path to start doing much better before finishing with 20 years of very good earnings.

The deferred income going towards a pension in the early years will have been at the standard rate or no tax while the pot that was eventually built will result in pension payments which attract the higher rates of tax.

Not hard to envisage at all. In fact I'd say bloody obvious. But then, that's me.

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kWIKSAVE

Dec 24, 2014 at 19:18

Like the increase in qualifying years to 35 on state pension, it's only a matter of time for there to be a flat 30% rate on personal pension contributions. This may tempt basic rate taxpayers to put more into their pension pot, including retirees on the max gross cont of £3,600 assuming this is not reduced.

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John Griffiths

Dec 24, 2014 at 19:40

Surely the tax free portion should be on your main pension fund only not available for recycling into a series of mini-pension funds?

If the tax benefit was kept to basic rate then the Exchequer would not have to pay so much into people's pension funds who were higher rate tax payers. They do actually have to use the tax make up cash.

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Briesmith

Dec 24, 2014 at 22:09

Current rules don't permit the re-investment of the tax free (25%) draw-downs into another pension although monthly and other pension payouts can be recycled in that way.

And there is no reason why they shouldn't. After all they are simply income you deferred in times gone by and on which you have now paid tax at your current rate. They are no different from income realised from any other source; a post-retirement job, dividends etc.

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Ossian

Dec 25, 2014 at 08:07

Webb appears to have been out to hit higher rate tax payers through threatening their relief since he got this job. He floats this idea and gauges the response on a regular basis looking for the tide turning in his favour. He either thinks the response is too negative or Osbourne tells him to take a hike every budget/pensions bill (I suspect a bit of both and mainly the latter). Quite why he's out to hit middle income earners I don't know but I suspect a naive political ideology is driving this thinking.

The thing is he may look at those middle income earners and think their life is easy but there are people in various circumstances in there (in my case I have nursery fees at one of the cheaper local nurseries of £19k per annum, add in mortgage, pension contributions, car, etc and there isn't much left) which means that for most it isn't poverty but it is a long way from the life of the indolent rich.

Frankly pensions should remain on a deferred taxation basis (pound for pound gross contributions) with the lump sum. We have just had some excellent liberalization enabling freer access on retirement to peoples own money. What we now need is a period of stability. Perhaps we should do without a pensions minister for the next 20 years to save some money but otherwise please give people some stability to plan for their retirement.

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Briesmith

Dec 25, 2014 at 10:44

What the article omits to mention is that Steve Webb is a Liberal Democrat MP (for Thornbury & Yate) and no one should be under any illusions as to what the LibDem position is on taxation. They like it, a lot, and they want a lot more of it.

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Anonymous 1 needed this 'off the record'

Dec 25, 2014 at 21:08

I won't be voting Conservative in 2015. They used to be the party of aspiration and opportunity with their focus on home ownership and providing the working and middle classes with access to the same quality of education that wealthy families have been buying for their children for generations but now they are led by the privileged few and represent their interests solely.

They have attacked middle income earners continually since coming into office in 2010 and need to be reminded who put them into power. It isn't the high income earners or the inheritocrats, they will always vote Conservative, it's middle income earners with little real wealth who would probably manage just fine under a Labour or Conservative government.

Of all the smug Tory ministers, Steve Webb is the biggest irritant. Apart from removing the need to buy an annuity and auto-enrollment, everything else he has done has either restricted the ability of people to save for retirement, reduced the incentives to save, or undermined confidence in the system by tinkering.

Conversely, if both parties hadn't borrowed the UK to the brink of bankruptcy and artificially depressed interest, gilt, and annuity rates so they can service the debt, for many annuities would still be the best way of providing a guaranteed income in retirement.

Furthermore, auto-enrollment is fine but since the Conservatives take great delight in creating any old low paid, zero hours contract jobs for the indigenous working classes, forcing employers to make a low single digits % contributions of a low wage isn't going to make those people that much less dependent on the state in old age than they otherwise would have been.

The Conservatives have lost their way and ran out of ideas, they continue to cripple future generations with more and more debt just like the last lot. The UK needs radical change, not just the Labour Conservative tag team wrecking ball, each one trying to borrow and spend more than the last to buy votes, leaving the next lot to sort out the mess.

I have to thank Steve Webb for one thing, encouraging me to save a small fortune in my pension fund in the last couple of years before higher rate tax payers have to start cross-subsidising everybody else. Knowing the Conservative's penchant for stoking property bubbles and passing it off as economic growth even guided me on what funds to invest in. I have paid about £75k less in income tax than I would have done if Steve Webb hadn't made lobbying to abolish higher rate tax relief his mission in life. No wonder George Osborne and the Treasury ignore him.

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geoffrey mulford

Dec 25, 2014 at 22:28

So lets get this right. Under the present system a person that earns just under the 40% tax limit can put £20,000 into his pension and ends up with £25,000 with his tax added. A person that earns £1 more puts £20,000 into his pension ends up with £33,333 with tax added. is that right?

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Briesmith

Dec 25, 2014 at 22:47

@ Geofrey Mulford

No; it couldn't be more wrong. Income tax rates are marginal rates not absolute rates like Stamp Duty say.

The income tax paid or deferred relates only to the income that lies within the band; having some income in the 40% band doesn't qualify your salary in its entirety for 40% tax relief. Just those pounds in the 40% band.

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Ossian

Dec 25, 2014 at 23:18

@ Geofrey Mulford

as Briesmith says the relief is at the marginal rate.

So for the £20,000 there is relief at 20% claimed by the pension provider, resulting in £25000 contributed to the pension scheme. For the person paying £20,001 who is £1 over the higher rate tax threshold, there is £5000.25 relief at source resulting in a gross contribution of £25,001.25 and an additional 25 pence of tax relief can be reclaimed by making a tax return after the FY ends.

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Roy Harding

Dec 26, 2014 at 01:36

As a BR taxpayer I see no problem with higher rate tax relief on pension contributions so long as it is limited, which it is.

Recycling - drawing money from one pension and paying into another is an abuse IMO.

It is easy to stop. If you have withdrawn money from one pension no tax relief available on any further pension contributions.

It would stop abuse and also stop pension savings being used as general savings, withdrawn at will.

Historically you had to retire to access your pensions - returning to that discipline would be no bad thing.

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geoffrey mulford

Dec 26, 2014 at 08:54

@ Briesmith

Thanks for your reply. It seems strange because I am putting all this years wages into my pension and getting tax relief at 20% even on the first £10,000 that I don't pay any tax on.

I think the pensions still could do with reform. The main way that a pension benefits you is if you put money in at one tax level and draw it out at a lower tax level. There is no point me having a pension that pays out more than my £10,000 a year tax free limit.

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andy

Dec 26, 2014 at 10:03

Geoffrey

Thats fine - you will simply need to declare it as part of a self assessment return in January and ensure you pay the additional tax otherwise you will be liable to fines for not paying the correct tax.

Always remember that you are personally liable for ensuring you pay the correct tax - I know people who comment I am not a tax specialist I employ an accountant or my employer got it wrong. Does't wash with the Revenue. Amusingly if you ask them for a list of their competencies - tax isn't one of them. So even when they "tell" you to do something - if it is wrong - you are still liable (as I discovered as a 20 something year old).

Andrew

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David 111

Dec 26, 2014 at 14:52

Roy Harding - Your proposal makes a lot of sense.

Geoffrey Murford - how nice it must be to be in a position where you can pay all your wages into a pension. You obviously have other sources of income to pay for day to day expenses. As I said, how nice it must be to be in that position.

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