The first of the thirty or so recommendations for tax reform to be made in the Taxing Wealth Report 2024 has been published this morning. It looks at the cost of pension tax relief for the highest earners in the UK who are provided with that relief at the 40 per cent and 45 per cent rates of tax at present.
This note is of almost 3,000 words and so too long to share here. The brief summary says:
Brief summary
This note suggests that:
- The higher rates of tax relief on pension contributions made by those who are 40 per cent and 45 per cent taxpayers in the UK are inappropriate. Everyone should get tax relief on their pension contributions at the same rate of 20% that is now made available to basic rate taxpayers.
- All such higher rate tax reliefs be abolished with some restriction on associated national insurance reliefs also being made.
- As a result, £12.5 billion of tax reliefs might be withdrawn each year, plus maybe £2 billion of national insurance reliefs. As a result, that much additional tax will be paid.
- If this recommendation is adopted the cost of tax reliefs on pension contributions made by higher-rate taxpayers in UK might still amount to approximately £24 billion a year, or £5,450 a year each, compared to approximately £8,750 a year each at present. The average basic rate taxpayer receives a subsidy of approximately £1,050 a year on their pension contributions at present.
- Changing these reliefs will not seriously change the savings habits of the people impacted as pensions will remain by far the most attractive tax-incentivised savings arrangement available to them and more than eighty per cent of UK financial assets are held in tax-incentivised savings arrangements.
Additional comments
This proposal is one of the most straightforward of all those in the Taxing Wealth Report 2024. The data that underpins all the findings comes straight from that published by HM Revenue & Customs. The restriction would be easy to introduce, in stages if that was politically necessary.
Retaining this relief is very hard to justify. It cannot be right that the most well-off in the UK get tax relief on their pension savings of £8,750 on average each year, which sum is only a little less than the basic UK state pension (£10,600 pa at present). Reform to end this obvious economic injustice is overdue for that reason.
Reform is also required because it is inappropriate to provide higher rates of tax relief on savings to the already wealthy than that provided to those less well-off. Ding so is clearly economically and ethically unjustifiable.
£14.5 billion could be raised by this reform, which is more than many suggest could be raised by a wealth tax each year.
The report on which this note is based
The note on which these observations are based is available here. If commenting, please read that note first.
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I would like to see all tax relief limited to the basic rate. Tax avoidance would be less attractive if the returns were less and those with the highest incomes could become less greedy and selfish if their high incomes were being used as a benefit to the whole of society.
Do you need to qualify the amount of basic state pension mentioned here?
Only those men born after 6th April 1951 and women born after 6th April 1953 get £10,600.
Those born before those dates get £8100.
I accept the point.
The report briefly mentions national insurance but it is not clear (to me at least) if you are proposing to change the tax and NI treatment of employer contributions, or the treatment of benefit accruals in final salary schemes.
Employee pension contributions are made out of the amount left after NI is paid, so it appears you are suggesting that higher and additional rate employees should pay tax and NI on contributions made by their employers, and on DB accruals (the latter will affect many public sector workers, including the senior doctors who are in the news recently, who declined to work overtime due to the adverse tax implications). Is that right?
NI relief on pensions costs £23 billion pa because of reduced rates. I am suggesting restriction to that relief.
Sorry, what reduced rates?
As the HMRC data says in black and white (well, the bar on the graph is orange), £23 billion is the estimated annual amount of primary and secondary class 1 NIC foregone on employer contributions to registered private pensions.
So it appears you are proposing to require employees to pay NIC on employer pension contributions. I can see the intellectual case to ending the beneficial treatment of salary sacrifice (although that is a small part of the employer contributions shown in Table 6) but I just want to be clear.
Would the same (that is, making individuals pay income tax and NICs) apply to increased entitlements under defined benefit pension schemes? Or to employer contributions to defined benefit pension schemes?
I am not sure what the issue is.
That is what I am proposing for those with earnings over £100k.
I accept I have not worked through your last points – but precisely for that reason kept the estimate pretty low. I think a restriction of this sort is appriopriate.
Just trying to work through in my mind what the consequences might be.
From Table 6.1 and 6.2, defined benefit contributions account for more than half of the total, so that are an important element. Many of these workers don’t realise how valuable their pension rights are but perhaps requiring some of them – the higher earners at least – to pay tax on increases in value will bring it home.
I can see the logic of restricting income tax relief for higher earners to the basic rate – and that should be relatively easy to implement. The result will be I would suggest much reduced pensions savings and wodges of cash looking for other homes subject to less onerous restrictions. I suspect many people will just ask for cash and make their own investment decisions rather than agreeing to let their employer lock up money in a pension for decades.
But I don’t really follow the logic of including NICs in the change. Looking again at Table 6.3. those people will be paying NICs at the 2% rate above the upper earnings limit, and that is a very small fraction of the whole (under £1 billion of over £8 billion of primary class 1 NICs relief on employer contributions – amounts paid by employees from net pay already bear NICs and they don’t get that back – but I suppose HMRC might get another £7 billion or so from employers as secondary class 1 NICs, less 25% from corporation tax relief ).
More than 80% of all financial assets are in tax incentivised arrangements
85% plus of pension contributors save despite only getting basic rate relief
I really do not think the wealthy are going to give up on pensions
Re NIC: I accept the issue is not straightforward. But do you think £23 billion is not worth thinking about? I do…
I am generally supportive of your work and excited by your Taxing Wealth project and I agree with the principle of restricting pension tax relief.
However, I think you are overly optimistic when you say that your plan is relatively straightforward to implement and will not seriously change the savings habits of the people impacted. This is for at least three reasons which I would be grateful if you could address.
Firstly, how practically speaking is this implemented in terms of removing the relief? Leaving aside the NI complexities, just for income tax, the straightforward way is to say that the income you save into your pension is taxable income (and forms part of your adjusted net income) but that you then get 20% relief on it. However, this would have the effect of pushing up the effective income tax band that many income tax payers are in. E.g. a 20% basic rate tax payer might become a 40% higher rate tax payer. In fact one of the inequities of our tax system is that the effective marginal rate of tax goes up and down so much as income increases due to not just the main tax bands, but student loan repayment thresholds, the High Income Child Benefit charge, the withdrawal of the personal allowance and so on. Many people limit the impact of this on them via pension tax relief. Is it fair if they can no longer do this? Is it fair that 20% tax payers become 40% tax payers because of your plan exacerbating the fiscal drag of recent years?
Secondly you are recommending this be brought in with only a year’s notice. This does not seem fair for those impacted who are nearing retirement for they will have little opportunity to adjust their savings plans to compensate, yet many people make a significant contribution to their pensions in the final years before retirement due to having paid off a mortgage or children having left home. How will they be able to adjust? When the government has changed the state pension age they have given many years notice so that people can adjust their plans, and when, for some cohorts, this has been poorly communicated they’ve been rightly criticised.
Thirdly you mention those who are higher rate tax payers when earning who are basic rate tax payers in retirement and seek to address what you see as the unfairness of this. However, what about those who are higher rate tax payers when earning but who believe, even if they’re mistaken in that belief, that they will be higher rate tax payers also in retirement? At present they’re taxed (ignoring NI) at 0% on the way in and 40% on the way out. With your proposal they would be taxed at 20% on the way in and 40% on the way out. This is 20% points more. I wouldn’t be so sure that this will not impact the savings habits of those impacted. You allude to other plans to limit ISA contributions. Without any change there surely ISAs would become more attractive for such people than pensions with people perhaps limiting their pension contributions to whatever is needed to get an employer contribution. So I think the totality of your changes are needed to understand whether behaviour will change. You might end up in a situation where you’ve simply brought forward income tax receipts, with some people paying more income tax whilst working but less income tax in retirement.
Apologies for the delay.
1) All tax relief would be given at source at a single rate, either through a payroll or when making direct contribution.
2) This would greatly simplify the tax system.
3) It would mean tax bands would work as advertised. Tax planning would reduce. The law would work as intended, even though you do not seem to like this – which is a position you need to justify.
4) I thought a year’s notice rather generous.
5) your claim that people will be taxed 20% when paying into a pension under my proposal is bizarre when they will actually get 20% subsidy fir their savings from the state.
Might I suggest you feel very entitled and that is showing in al, your comments. Why do you think it reasonable the state should support you so very heavily?
[…] on their pension contributions than those earning less. Restricting pension tax relief to 20% would raise up to £14.5bn a year, according to Murphy’s […]
Hi,
Can I ask what the impact of reducing pension tax relief would be for someone like me who is a high earner who contributes to a final salary scheme?
I earn £80k. My pension contributions are £907pm (with employers on top). In my simple mind, reducing the tax relief from 40% to 20% on my £907 contribution means reducing it from £368 to about £180. Is that right? And if so would that mean that my take home pay would reduce by £180pm?
If this is correct, then whilst you’re right that it won’t stop pensions being attractive as savings vehicles, I think you’re wrong to say that it won’t change savings habits. People will have a lot less money in the take-home pay (in my example that’s a 7% cut in my take home pay) so won’t be able to afford to save at all.
High-earners are not necessarily wealthy. Especially younger ones paying an additional 9% of their income in student loan repayments and sky high housing costs. That seems to be forgotten sometimes.
Tell me why you think you need a pension subsidies from the state of £368 a month when many receive not a lot more i8n benefits?
Why are you worth so much more than people on lower incomes are?
I would really like to know.
Pension tax is an absolute mess, and just working out how much an individual can contribute without having to repay the relief at source (i.e. effective tax relief achieved) per year you have to go through so many tests about relevant UK earnings, annual allowance (both in year and any unused allowance carried forward), lifetime allowance. DB and DC schemes are (required to be) treated differently etc.
I think to get to something sensible here a future Government would have to reform the whole system, rather than adding an additional layer over the top (which got us into the current mess in the first place). If we want people to get a degree of tax relief for their contributions, and that to be understandable to the average person (rather than only if they pay a pensions tax adviser a hefty fee) there is much work to be done. Pensions and tax are (on their own let alone together) very complicated and currently poorly understood by most.
I don’t think payroll systems would be able to cope with the amount of factors that currently influence whether relief is available even for income tax purposes . (My understanding is NIC is even more complicated).
Thanks for this Claire
First, for 95% of people I suspect there is no problem calculating whether contributions allowable – that is only an issue for the wealthy.
What I am offering is a massive simplification – all relief is at source and not via the tax return. That must be a plus, surely?
And as to the rules – they undoubtedly need reform, but does anything I suggest impede that (excepting on NIC, where I accept restriction on reliefs will be more complicated).
I’ve seen recent reports that pensions are likely not going to provide needed income during retirement. Can a case be made for raising the level of basic relief, while still equalising the rate between basic and higher rates, and using this to provide additional contributions to pensions to offset the shortfall? A standard rate between 25% and 30% would in effect divert the excess tax relief for higher earners to those less well off and mitigate to some extent the shortfalls during retirement that many are likely to face.
Why?
Wouldn’t it be better to direct funds into the investment we actually need rather than into savings, most of which are used for speculation? Until pensions are actually invested why do we need to subsidise them more?
What do you mean, not likely to provide needed income? There are millions of pensioners already who do not have the needed income.
What is inherently wrong with getting tax relief at your marginal rate of tax given pensions are deferral mechanism only? If the pension assets then grow and generate an income which is then taxed at 45% then there is no loss of tax only deferral of the tax payable.
If you want to eliminate an anomaly then remove the 25% tax free lump sum. There does not appear to be a reason why this continues.
You are a time waster.
First 25% of funds can be taken tax free. Second few pensions are taxed beyond basic rate.
So I am reflecting the actual deferral.
[…] The net cost of pension income tax and NICs relief is estimated to be £48.2 billion in 2020 to 2021. About two-thirds of this goes to wealthy individuals paying income tax at the marginal rate of 40% (on income between £50,271 and £125,140) and 45% (on income over £125,140). People with annual incomes below £12,570 get no pension tax relief. By restricting tax relief/credit to everyone at the rate of 20%, the government can generate £14.5bn a year. […]