Be brave Osborne and cut higher rate pension tax relief
Filed under: Pensions
The story of the higher rate pension tax relief has much in common with the tale of The Boy Who Cried Wolf. Every Budget, emergency Budget, and Autumn Statement heralds the announcement that 'the chancellor is cutting 40% relief'.
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For those who don't know, everyone receives pension tax relief on their pension contributions. Effectively you get your income tax back in the form of a pension top up, so those paying basic 20% tax get 20% back, and those paying higher rate tax get 40% back.
The government wants us to pay into pensions and tax relief is its way of saying well done on your contribution and encouraging us to put away more. The problem is that it is very expensive. Total pensions tax relief costs the government around £28.8 billion a year, according to Treasury figures and higher rate tax relief makes up a £7 billion cost of that.
The premise of pension tax relief makes sense but it just isn't fair, or affordable to give the largest tax breaks to the wealthiest.
The main problem with higher rate tax relief is that the government doesn't 'get the money back' when you take your pension. Pensions are taxed but when you reach retirement, unless you are particularly wealthy, you will most likely be a basic rate taxpayer – even if you have been a higher rate taxpayer for much of your working life.
So you can see the conundrum: basic rate taxpayers get 20% pension tax relief and then will pay back 20% income tax on their pension – even Stevens for the government.
But a higher rate taxpayer takes 40% tax relief but goes on to pay 20% income tax on their pension – the government is out of pocket.
I agree that it is unwise to keep changing the rules around pensions as it discourages saving but the government needs to take the bull by the horns, make some changes that may be unpopular. but will be more sustainable, and create a pension system that will work, is fair and won't need tinkering with for a long time.