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Call to introduce lower annual pension limit and flat rate of tax relief

Paloma Kubiak
Written By:
Paloma Kubiak

A group of MPs has called for a number of changes to the pension landscape, including replacing the lifetime allowance with a lower annual limit and introducing a flat rate of tax relief.

The influential Treasury Committee has today published its Household finances: income saving and debt report, where it makes a number of recommendations to the government.

One of the areas is on pensions, in light of auto-enrolment, a move from defined benefit to defined contribution pensions and pension freedoms.

Pension savers receive tax relief on contributions and in 2016/17, the cost to the taxpayer of income tax and NICs relief on pensions was around £41bn. But the tax relief has become less generous in recent years, the Committee said.

The annual allowance currently stands at £40,000, compared with £255,000 in 2010/11 but for high earners, they have to contend with the tapered annual allowance. Further, the pension lifetime allowance has also fallen from £1.8m to £1.03m.

Given the changes, there was widespread scepticism about the effectiveness and fairness of tax relief in incentivising pension saving.

Former pension minister, Baroness Ros Altmann, told the Committee: “The way tax relief works, of course, gives most incentive to those who are at the top end. Indeed, in some cases, those people who have no financial education at all, when they hear “tax relief”, think it is some kind of tax and not a good thing but a bad thing. The 20% tax relief is equivalent to a 25% bonus from the government—free money.”

Michael Johnson, of the Centre for Policy Studies, told the committee: “I would scrap all pensions tax relief, including employer NICs rebates. That creates a cash flow of about £46bn a year. I would introduce a bonus structure that is an incentive disconnected from your tax‑paying status. I would also bring down the annual allowance from today’s £40,000, which is irrelevant to virtually everybody in the country, to a number between £8,000 and £10,000. I would abandon the lifetime allowance as a quid pro quo, because it is essentially manna from heaven for consultants and does not do a great deal for everybody else.”

Given the feedback, the Treasury Committee stated the following: “There is widespread acknowledgement that tax relief is not an effective or well-targeted way of incentivising saving into pensions. Ultimately, the government may want to return to the question of whether there should be fundamental reform.

“However, the existing state of affairs could be improved through further, incremental changes. In particular, the Government should give serious consideration to replacing the lifetime allowance with a lower annual allowance, introducing a flat rate of relief, and promoting understanding of tax relief as a bonus or additional contribution.”