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Will a new ruling party end 40 per cent pensions tax relief?

Will a new ruling party end 40 per cent pensions tax relief?
February 26, 2015
Will a new ruling party end 40 per cent pensions tax relief?

But like the boy in the Aesop's fable, these proved to be crying wolf. Plenty of pension rules have changed, particularly in the past year, but higher-rate tax relief on pensions has remained. As Samuel Croxall, a translator of Aesop's fables into English in 1722, said: "When we are alarmed with imaginary dangers in respect of the public, till the cry grows quite stale and threadbare, how can it be expected we should know when to guard ourselves against real ones?"

Now that we are six weeks from the end of the 2014-15 tax year, should we take notice of the growing cries for the end of higher-rate tax relief? With a general election coming soon and a potential change of government, the possibility is certainly there. Tom McPhail, head of pensions research at Hargreaves Lansdown, says: "Taxes tend to rise in the first Budget after a general election. It is inevitable that the next government will consider pensions tax relief when looking at how to improve the nation's finances."

In 2013-14, tax relief on pension contributions cost the taxpayer £34.8bn, according to HM Revenue & Customs. But research in 2013 from the Pensions Policy Institute said a 30 per cent flat rate for all, although fairer, would leave government revenue unchanged.

Flat-rate tax relief for all could mean the system is fairer and better targeted. But the principle of the current system is to avoid double taxation. The basis of a pension is deferred pay - you take pay you do not need now and lock it away. No tax on the pay deferred, no tax on the growth and then taxed as earned income on the way out. You pay money into a pension with full tax relief on your income, but have to pay tax at your full rate when you draw money out as your retirement income. That seems fair too, with the main incentive for pension savings being the 25 per cent tax-free lump sum on retirement.

But today's pensions system is imprecise, with non-taxpayers receiving basic-rate relief and higher-rate taxpayers usually becoming basic-rate taxpayers in retirement. People only benefit fully from pensions in particular circumstances and it is hard to tell if you will be in this group when you start a pension.

In 2014 a report from the Centre for Policy Studies said retirement saving incentives which cost a staggering £54bn a year are an ineffective, and inequitable, use of Treasury funds. The author, Michael Johnson, called for governments to scrap pensions tax relief and introduce a 50p per £1 saved policy, irrespective of taxpaying status.

Pensions Minister Steve Webb (Liberal Democrats) recently raised the notion of moving to a flat rate of tax relief for all pension contributions, irrespective of the rate of income tax an individual pays. He talked about a 33 per cent rate of relief which he suggested might be tax-neutral if it discouraged the use of "salary sacrifice" arrangements used by employers and employees, as well as removing the lifetime allowance limit as a sweetener for the higher earners who would see their rate of tax relief drop from 40 per cent to 33 per cent.

He sais: "I don't believe tax relief incentivises savings other than the very rich at the moment.

"If you do reform tax relief in the way I have described, one of the great simplifications would be that you could abolish the lifetime limit."

However, Mr Webb's views are not official Liberal Democrat policy (see below).

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