Budget Question: Will Chancellor Reduce Tax Benefits on Pensions for Higher-Income Individuals?
The UK government is considering significant changes to the pension tax relief system, a move that could impact the retirement savings of millions of Britons. Here's a breakdown of the proposed changes and what they might mean for you.
Currently, savers can enjoy income tax relief on their pension contributions at their highest rate of income tax. This means that basic-rate taxpayers receive a 20% relief, while higher-rate taxpayers enjoy a 40% relief, and additional-rate taxpayers get a 45% relief. Additionally, savers can withdraw up to 25% of their pension pot as a tax-free lump sum when they retire.
One of the proposed changes is to restrict tax relief to the basic rate only (20%), which would reduce the tax advantages for higher earners and increase government revenue. This could mean that higher earners would receive less tax relief upfront, potentially reducing the overall value and flexibility of pensions as a savings vehicle.
Another proposal is to reduce the amount of pension pot eligible for the tax-free lump sum from the current 25%. This would mean less tax-free cash available at retirement. Additionally, there are plans to delay access to the tax-free lump sum, so savers might have to wait longer before withdrawing any or all of the 25% tax-free amount.
These changes, if implemented, could have a significant impact on retirement planning and tax efficiency for many savers, especially higher earners.
It's important to note that these changes are still proposals and have not been confirmed. The government is also making administrative adjustments such as stricter evidence requirements for claiming higher-rate tax relief through tax codes, effective from September 2025.
Critics argue that an overhaul of the system could unfairly punish younger savers who wouldn't get the same boost to their pension funds as older generations. Younger workers who already benefit from less generous workplace pensions than their parents and grandparents could miss out on the potential benefit of higher-rate pension tax relief as they progress through their careers.
Moving to a flat rate tax relief system could also create complications. For instance, final salary pensions, which are mainly found in the public sector, could lead to public sector strikes when trying to fix them for a flat rate system. Fixing defined benefit pensions to work under a flat rate system could upset either higher or lower earners within the same scheme.
In conclusion, the proposed changes to the UK pension tax relief system could limit relief to the basic rate and reduce or delay the tax-free cash, impacting savers’ retirement planning and tax efficiency. However, it's crucial to remember that these changes are still proposals and have not been confirmed. Stay tuned for more updates on this developing story.
[1] HM Revenue & Customs. (2021). Pension tax relief. [online] Available at: https://www.gov.uk/pension-tax-relief
[3] HM Revenue & Customs. (2021). Changes to pension tax relief for higher rate and additional rate taxpayers. [online] Available at: https://www.gov.uk/government/publications/changes-to-pension-tax-relief-for-higher-rate-and-additional-rate-taxpayers/changes-to-pension-tax-relief-for-higher-rate-and-additional-rate-taxpayers
[5] HM Revenue & Customs. (2021). State Pension. [online] Available at: https://www.gov.uk/state-pension
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