From the TUC

Government limits higher rate tax relief on pensions

14 Oct 2010, by in Economics, Pensions & Investment

The government is to limit to £50,000 a year the amount on which people can claim tax relief on their pensions.

Inevitably the Daily Mail proclaims:

Middle classes hit again as tax relief is slashed on top-end private pensions

But very few people can afford to put this much into a pension in a year – and even those who get a one-off legacy or divorce settlement will also be able to roll over unused (FT £) allowances from the previous three years. £50,000 a year is more than twice median income. The same approach to geographical accuracy would put Iceland on the equator. This is a hit on the rich, not the middle.*

Tax relief is the pension world’s dirty little secret.  If you put money into a pension, your taxable income is reduced by that amount so you pay less tax. This means that if you are a higher rate taxpayer it reduces the amount of income on which you pay the 40p top rate of tax, so that it costs you just 60p to put a pound in your pension. But if you’re a standard rate taxpayer you  have to fork out 80p to save a pensions pound.

The introduction of the 50p tax rate for those earning more than £150,000 means that it now costs the super-rich just 50p to put a pound in their pension. Something tells me that they will be hitting this new limit on a fairly regular basis.  Buy a pension pound and get one free is not a bad deal.

This government move deserves a bit of a cheer. It is definitely progressive as it raises £4 billion from genuinely rich people, and does not have the problems associated with child benefit.

But it is also a missed opportunity. What we need is a much more serious look at what the state spends on pensions that takes into account the costs of tax relief.

For sure, there is some straightforward tax avoidance going on that uses pensions tax relief. I have no problem with the Treasury cracking down on this. Today’s announcement can be seen as a step on this road.

But  we have a number of big pensions issues in this country. Too many current pensioners depend on means-tested benefits to give them a far from generous income. A big proportion of those in work today in the private sector have little or no pension, and are too old to get much benefit from auto-enrolment and compulsory employer contributions.

There is growing interest across the political spectrum in looking at how changes to tax relief could be used to fund a more generous state pension (and the tax break lobbyists are getting worried). This need not involve getting rid of tax relief, but there are good questions to be asked about how far the state should go to encourage savings above a reasonable income standard in retirement.

This is not an easy or straightforward issue, but it’s certainly more progressive than paying for better basic pensions by raising the pension age. That simply redistributes money from poorer, shorter-lived pensioners to better off longer-lived ones.

So while it would be easy to say that I wish the government had gone further today – there’s also part of me that is glad that they have not yet closed off some higher rate tax relief as a source of funds for better state pensions that can lift people above means-testing levels.

* There is a small number of more modestly paid people in a DB pension who get a significant pay rise who will now be taxed on the increased value of their pension, but the roll-over limit will help many of these. This will also rightly catch those in gold-plated boardroom pensions who give themselves a massive pay hike just before they retire to boost their final salary related pension.

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