Latest Office for Budget Responsibility (OBR) estimates put the cost of Coronavirus government debt at £384bn, but with the economy still not firing on all four cylinders and job and business prospects uncertain, the eventual cost could be even greater.
How this is going to be paid for is likely to be the focus of the November Budget. Scrapping marginal rate income tax relief on pensions savings could be one way to claw back some of the government’s munificence.
The principle behind pension savings tax relief is that in return for depriving themselves of income earned today, so that they may have retirement income many decades later, the taxpayer may defer tax on pension savings until pension income is drawn.
Relief does not wipe out the tax bill but defers it, which could mean paying more, or less income tax later.
Pension funds incur no income tax or capital gains tax while invested. Up to 25% of the fund may be withdrawn tax free after age 55, the balance being subject to income tax at the marginal rate payable when withdrawn.
Those arguing for the scrapping of marginal rate relief say that the reforms introduced by former chancellor George Osborne’s ‘Pension freedoms’ from 2015 make it less likely that higher marginal rate tax will be payable when income is withdrawn. Flexible withdrawals make it possible for no tax to be paid with careful planning and little other UK taxable income.
In practice, pension freedoms have been a nice little earner for HMRC with many individuals, not taking professional advice, withdrawing large one-off sums becoming top rate taxpayers overnight. HMRC receives £15bn per year in tax receipts from pension income.
Over the last few years successive chancellors have considered a redistribution of this tax relief away from higher earners. This would be consistent with other personal tax allowances such as the personal allowance, savings interest, marriage allowance, and tax-free child benefit, all of which are reduced or removed for higher rate and top rate taxpayers.
Covid-19 and its aftermath has given fresh impetus to this debate, with a growing chorus of calls for a review of the value for money provided by giving marginal rate relief to higher earners. The argument of those who seek this reform is that a disproportionate share of the £35.4bn annual cost of this relief goes to higher and top rate taxpayers who not only get a higher percentage of relief but also make larger contributions to their pensions than the average person.
A recent briefing note from the Pensions Policy Institute, sponsored by the Association of British Insurers, explored the argument for a flat rate of relief, for all saving in defined contribution pensions which might be set at 20%, 25%, 30% or 33%. The thinking is that a reduction in tax relief would not make pension saving less attractive to higher earners but would incentivise basic rate and non-taxpayers to save more.
This argument assumes that higher earners would be able to fund the cash flow disadvantage of paying a marginal higher rate of tax on income saved but which could not be accessed until age 55 or later, with 75% of that income then subject to income tax at their marginal rate when drawn.
It also ignores that current rules restrict the amount of relief available to the individual, with both a lifetime allowance (£1,073,100 in 2020-21) and an annual allowance of £40,000 for those with adjusted income up to £240,000.
Following the March Budget, many higher and top rate taxpayers will be able to save more in pensions in 2020-21. Those with income between £110,000 and £300,000 saw restrictions on pension savings allowances lifted substantially.
Those with adjusted income over £240,000 can now save a gradually tapered amount higher than previous restricted allowances until adjusted income is £300,000. But a lower allowance of between £9,999 and £4,000 applies to adjusted income above this and a flat £4,000 on income of £312,000 or more.
This easement of the restrictions of high earners tax relief was largely prompted by the complaints of doctors and other key workers, in public sector defined benefit schemes, who were suffering annual allowance tax charges which made overtime unattractive.
An interesting development in the latest debate is that reform of marginal rate relief appears to be focused on savers in defined contribution schemes only, disproportionately private sector workers and the self employed. Yet of the £35.4bn annual cost to taxpayers, only £9.2bn is attributable to income tax relief for defined contribution schemes, the bulk of the cost is spent on defined benefit schemes.
In a recent call for evidence on lower paid workers and pensions tax relief, the Treasury is considering mandating the relief at source (RAS) method of tax relief for all defined contribution schemes. That would make the administration of a flat rate of relief easier for payrolls and HMRC to administer.
Should these reforms be implemented, the gulf in taxpayer support for predominantly private sector defined contribution savers and largely public sector defined benefit savers would grow and could only be levelled up by the abolition of the lifetime allowance recovery charge for defined contribution savers.
Higher and top rate taxpayers may wish to bring forward decisions on pensions savings in case changes to the current marginal rate relief are included in the November Budget
Contact MCL Accountants Southend today on 01702 593 029 to optimise your tax position or if you need any assistance with your company accounts or to optimise your tax position.