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Pension tax relief will blow hole in Labour's spending plans

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Pension tax relief will blow hole in Labour's spending plans

Labour has said it will not change pension tax relief in correspondence to its proposed changes to income tax, despite concerns pension contributions could be used to get around the tax increase for higher earners.

Today Labour announced plans to introduce a 45% income tax for earners over £80,000. Those who earn £123,000 or more will pay a 50% rate under the proposals. 

However, the Institute for Fiscal Studies (IFS) has pointed out a flaw in the plan: tax relief on pension contributions.

Currently people receive tax relief on pension contributions which is equal to their marginal rate of income tax. So it follows that if the government increases the amount of tax an individual pays, the amount of relief they receive on pension contributions also increases. 

As the IFS points outs this gives those affected by Labour's proposed increase in income tax a way of reducing their tax bills and actually receiving more from the government, albeit in a way that keeps savings locked up until they turn 55. 

 ‘One straightforward response for many would be to increase their contributions to private pensions, which bring up-front income tax relief. They could also work less, make greater efforts to avoid or evade tax, emigrate, or not come to the UK in the first place,’ the IFS said.

Steven Cameron, pensions director at Aegon, also highlighted this potential loophole and pointed out 'offering greater tax relief to a larger number of "higher earners" doesn’t fit well with Labour’s broader intention'.

So will Labour also look to reform pension tax relief? The answer is no for now. 

A Labour Party spokesman told New Model Adviser®: 'We have no plans at present to change the system of pensions tax relief corresponding to the marginal rate.'

It seems unlikely this can remain the policy going far into the future. As the IFS has pointed out, with such a system in place Labour is unlikely to bring in as much money as it has forecast from the tax increases, potentially putting other promises at risk.

‘Labour is proposing to raise income taxes for the highest-income 2% of adults. Many would take action to reduce their taxable income in response: for example by increasing contributions to private pensions,' IFS associate director Robert Joyce said.

‘Because the extent of those kinds of responses is very uncertain, the amount of extra revenue these higher tax rates would raise is also very uncertain. Labour’s policy could raise something like the £4.5 billion per year it expects, but it could also raise nothing.’ 

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