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Why the 1p income tax cut could knock £1,000s off your pension

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24/03/2022
The government announced a 1p cut to the basic rate of income tax from 2024. While seemingly positive for workers, the move could have a significant impact on pension savings.

In a bid to help people keep more of their wages as the cost-of-living bites, the chancellor Rishi Sunak announced that from April 2024, the basic rate of income tax will fall from 20%, to 19%, so 19p per £1 earned will be taxed, down from 20p.

Sunak said the tax cut for workers, pensioners and savers would be worth £175 on average for 30 million people.

He hailed the move as “historic” adding that it was the first cut to the basic rate in 16 years.

While a welcome move, it needs to be seen in the context of pension savings.

One of the benefits of saving into a pension is that you receive tax relief from the government. The amount you get depends on your income tax bracket.

Basic rate taxpayers get 20% relief, higher rate taxpayers get 40%, while additional rate taxpayers get 45%.

As the income tax for basic rate taxpayers is set to fall, pension tax relief will also fall in tandem.

Kate Smith, head of pensions at Aegon, explained: “People receive tax relief on pension contributions at their highest marginal tax rate. A reduction in the basic rate of income tax means people will get lower tax relief on their pension contribution, so the government top-up directly into their pensions will be less.”

She added that in order to get the same retirement income, people will have to pay a little bit more into their pensions.

“If they can, people may want to think about putting more into their pensions over the next couple of years to make the most of the current 20% tax relief,” she said.

These Aegon calculations show the difference in 20% and 19% tax relief, based on a £100 initial monthly personal contribution (£125 vs £123.5) for a 20-year-old set to retire at the age of 68. It shows pension savers could miss out on nearly £5,000:

These Aegon calculations show the difference in 20% and 19% tax relief, based on a £200 initial monthly personal contribution (£250 vs £246.9) for a 20-year-old set to retire at the age of 68. It shows pension savers could miss out on nearly £10,000:

*Calculations assume investment growth of 4.25% (5% incl charges), contributions increase by 3% annually. Fund value is in monetary terms and assumes no contribution from an employer.

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