As the pre-Budget autumn statement approaches, rumours are circulating about a plan to cut higher rate tax relief on pension contributions. Similar rumours surfaced in the run-up to the March 2012 Budget, and were unfulfilled.

The coalition did, however, reduce the annual allowance for pension contributions from £255,000 to £50,000 in 2010. According to the rumours, it is now looking at cutting the annual allowance further to £40,000.

Government tinkering

AXA’s head of technical sales Andy Zanelli says if this happens it would be more government tinkering, which would put another dent in the public’s confidence in the pension system.

‘How far do we go? How are you going to encourage employers and entrepreneurs to save for their retirement? £50,000 is reasonable,’ he says.

‘When we start tinkering around the edges, it is damaging. There is longer term strategy and then there are strategic manoeuvres; and this is one of the latter. It’s [merely] a tactical reaction.’

Causing offence

Chancellor George Osborne’s tactic, if that’s what it is, cannot be to please Conservative voters, who generally want less tax or more tax relief; nor can it be to please the wealthy, who receive 40% relief while they work; nor can it be to please older people, who may have left pension saving late and want to make large contributions. The measure would offend all these groups.

Its justification would be to gain the greatest amount of tax revenue for the least possible anger among average voters.

Yet according to independent pensions expert Michael Johnson, there are targets better serving that goal.

‘Higher rate tax relief is the lowest hanging piece of fruit in the whole of the Treasury,’ he says.

Doing the sums

Johnson believes the government should dispense with higher rate tax relief altogether, rather than chasing paltry sums by lowering the allowance.

‘It is going to have to happen,’ he says. ‘It’s first and foremost a finance point. If you cut higher rate relief, you save £5 billion a year. If you reduce the annual allowance to £30,000, you will raise only £1.8 billion.’

Providers have argued that cutting higher rate relief discourages company directors, entrepreneurs and other well-regarded wealthy people from saving into pensions, and that this has a knock-on effect by discouraging others, too.

But the providers’ argument is spurious. Many of these alleged role models are not saving and are not promoting saving. Research from Prudential has revealed that 60% of higher rate taxpayers fail to claim full relief on pension contributions, representing £296 million a year.

According to HM Revenue & Customs, only 55% of the UK’s 900,000 higher rate taxpayers contribute to a defined contribution pension. Scottish Widows research shows just 40% of the whole UK population saves with an employer.

Cautious about the consequences

Johnson says cutting higher rate tax relief would be straightforward. But even likely supporters of such a move, such the Labour party, are extremely cautious about it, and concerned about unintended political and tax consequences.

Reducing the annual allowance would be easy and could even be relatively popular if the revenue raised is clearly linked to a popular cause, such as funding the flat-rate state pension. So perhaps, this time, the rumours will prove well-founded.