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Government to examine pensions tax relief

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Written by: Emma Lunn
21/07/2020
Pensions tax relief rates could be overhauled after the Treasury launched a call for evidence about the government's understanding of the effectiveness of the system.

Under the current rules, the government provides tax relief on money which is saved into pensions by both individuals and employers.

This policy aims to encourage people to save towards their retirement.

The Public Accounts Committee (PAC) has called for the government to review its policy and the Treasury has now begun a consultation to see whether pension tax breaks, as a whole, are actually effective.

One issue the government is concerned about is the potential for a low-earning individual’s take-home pay to be affected by the method of pensions tax relief operated by their pension scheme.

Members of pension schemes who don’t pay income tax are granted basic rate tax relief of 20% on pension contributions up to £2,880 a year. This means HMRC will top up a net contribution of £2,880 to a gross £3,600.

But this tax relief is only available where the pension scheme operates on a relief-at-source basis. It is not available for schemes that operate a net pay arrangement, which are the majority of pension funds in the market.

The Treasury is asking for views on how certain proposals could be adapted to address the discrepancy in outcomes for low earners in a way that is consistent with the government’s principles for reform.

Andrew Tully, technical director at Canada Life, said: “Amending pensions tax relief has long been on the government’s economic horizon and this consultation may be the start of plans to introduce new measures at the budget later in the year.

“Many low-paid workers, mostly women, are missing out on the pension tax relief they are due because of the way net pay works. Sorting this will boost confidence in the auto-enrolment system as well as helping everyone benefit from pension tax relief. However, it’s crucial that any changes are made with simplicity in mind. The current situation is fiendishly complex and any poorly considered changes may only make this worse.”

According to calculations by Quilter, the net-pay tax flaw currently means some workers earning £12,499 a year could retire with a pot worth £59,000 while others will end up with £51,000. These estimations assume a 4% net investment growth after charges in both cases, and a retirement age of 68.

Jon Greer, head of retirement policy at Quilter, said: “This is a lottery depending on what tax system they end up in. Those in a net-pay scheme do not benefit from government tax relief into their pension pots, while other workers who are in a ‘relief at source’ scheme receive the top up.

“The four suggestions outlined in the consultation are intended to spark debate to find an appropriate solution. Part of the issue is who will bear the majority of the challenge to find a solution: the government or the employer. The administrative burden has always been an excuse to not fix the antiquated system.”

The Association of British Insurers called for an overhaul of the pensions tax relief system last month. A report from the Pensions Policy Institute (PPI) had found that higher earners, who are more likely to be men, benefit most from the current system.

The consultation opened today and closes at 11pm on 13 October 2020.

 

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