Why this could be the year of the pension tax relief raid

Estimated reading time: 3 minutes

Oct. 12, 2018

Rumours suggest the Budget will see Philip Hammond finally get his hands on the billions tied up in it. It is never easy to predict with any degree of certainty what the chancellor may or may not do in his Budget when it comes to pensions. 

The last two years have been surprisingly quiet on that front, but history suggests this is unlikely to continue for a third year. We also have the massive uncertainties this time round arising from Brexit. At this point in time, it is anybody’s guess how that is going to end up or the impact it will have on the economy more widely.

There has already been a good deal of speculation as to what may be coming for pensions in the Autumn Budget. Some of this may be just that – speculation, without any foundation in fact. Other suggestions may have come from inspired leaks from the Treasury or similar official sources to test the water before proceeding. We will never know for sure.

What does seem likely, however, is that, for a cash-strapped chancellor looking to bolster his finances, pension tax relief will be a tempting target. Currently costing the Exchequer over £38bn a year, it may be the only place for him to go to raise the sort of money he needs.

The government has committed itself to provide extra funding for the NHS to the tune of some £20.5bn by 2023/24. This is hardly chicken feed; the money has to come from somewhere. One very strong rumour doing the rounds is that the government will cut the annual allowance in half to help drum up the cash needed.

Currently, the limit is set at £40,000 a year. If reduced to £20,000, this would mean a high earner with a 40 per cent tax rate only receiving £8,000 of tax relief, instead of £16,000 as now. But the saving for the chancellor would be much less marked when it comes to lower earners. Most of the people that contribute to a pension plan put in fairly small amounts and might not be affected by even a £20,000 limit. So this idea on its own may not provide the sort of money saving Philip Hammond is looking for.

His next target, then, could well be the rate of tax relief on pension contributions. A curtailment or abolition of the higher rate could be more difficult politically for a Conservative chancellor to bring in, but he might be able to get around this by introducing a flat rate for all of 25 per cent, as one anonymous source has already indicated. This would still be a reduction in tax relief for higher (40 per cent) and additional (45 per cent) rate taxpayers but could be promoted as a real-time increase for standard (20 per cent) rate and non-taxpayers.

As by far the bulk of the tax relief given currently goes to the higher rate taxpayer, it could also be justified as a more equitable share-out of the tax relief pot available between the different levels of taxpayers involved. On the operational side, the introduction of a flat rate of tax relief could possibly require some significant changes in current practices, particularly for payroll operatives.

It would mean the net pay system of providing tax relief used mainly by occupational schemes might have to be abandoned and replaced with the relief-at-source arrangements now commonly in use in defined contribution workplace pension schemes. Continuing to use net pay as now would result in higher rate taxpayers receiving too much relief and standard rate taxpayers not enough. Moving to relief-at-source would be more difficult for schemes administratively but would at least ensure all non-taxpayers entitled to relief actually got it. But all of that will depend on exactly what Hammond decides to do.

We must wait for details to be announced in his Autumn Budget, which is due to be delivered on 29 October, to get the full picture.

This article previously featured in Money Marketing.