Slash tax relief on higher earners’ pensions pots to boost incomes

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The Government is being urged to reduce tax reliefs on wealthier pension pots while boosting help for people with poorer plans by the Institute for Fiscal Studies. The current system of pensions tax provides tax breaks which are overly generous to people with the biggest pensions, high retirement incomes and those in receipt of large employer pension contributions, a report has said. Researchers at the IFS say the system does relatively little to support many of those facing low income in retirement, who most need it.

A report published today (February 6), funded by the Financial Fairness Trust, outlines proposals to even out tax support for pension saving by reducing subsidies where they are overly generous and increasing them where saving incentives are weaker.

The reforms would boost the retirement incomes of the bottom 80 percent of earners and provide greater encouragement for them to save more in a pension, according to the report.

Getting rid of overly generous subsidies which benefit those on high incomes could also lead to the removal of the complexities created by tapering away annual and lifetime savings allowances, the report says.

Isaac Delestre, a Research Economist at IFS and an author of the report, said: “Pension saving is treated generously for high earners. Even under pension caps, over £250,000 can be withdrawn from a pension free of income tax. Employer pension contributions escape National Insurance contributions entirely. And pensions are an easy-to-use vehicle for avoiding inheritance tax.

“At the same time, the 25 percent tax-free component is worthless to those who do not pay income tax in retirement. And those making individual pension contributions receive much smaller subsidies.

“Our proposals would boost the retirement incomes of low and middle earners and provide greater encouragement for them to save more in a pension. They provide a coherent vision for the taxation of pensions and don’t require the complexity, and big losses for some current basic-rate taxpayers, that would result from restricting income tax relief to the basic rate, for which some have argued.

“This evening-out of tax support for pension saving would be more equitable and more economically efficient, and would allow the current set of poorly designed limits on what individuals can save in a pension to be relaxed.”

The lifetime and annual limits on the amount which can be saved free of income tax in a pension have been cut sharply since 2011, especially for the highest earners.


This has raised taxes by an estimated £8billion a year, created complexity and damaged disincentives for an increasing number of higher earners, the IFS report says.

The research proposes reforming the current 25 percent tax free component to create a more equal subsidy for all private pensions.

Under the current set up, people can take a quarter of their pension free of income tax. The report acknowledges this is popular, but adds that while this provides a “large” tax subsidy to those with high incomes and big pension pots, it is of no value at all for non-taxpayers, who have the lowest incomes in retirement.

At a minimum, the tax-free component should be capped so it only applies to 25 percent of the first £400,000 of accumulated pension wealth, according to the report.

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This would leave about four-in-five of those approaching retirement unaffected, the researchers say.

A further proposal includes giving up-front employee National Insurance Contributions relief on all pension contributions, taxing pension income instead.

Mr Delestre said: “We would retain the current system of up-front relief from income tax that is of much benefit to higher-rate taxpayers. But our proposal to move employee NICs to a similar basis would benefit low and middle earners making individual pension contributions at the expense of higher-rate taxpayers enjoying large employer pension contributions.

“Our system of pensions taxation has too many features that are arbitrary, wasteful or unfair. It’s long past time we retired them.”

Mubin Haq, Chief Executive of abrdn Financial Fairness Trust, said: “Collectively, we save £115 billion a year in workplace pensions, with these savings treated generously by income tax, National Insurance and inheritance tax. But many of these tax reliefs are more generous to those with the largest pension pots, whilst millions of those on low-to-middle incomes are likely to fall far short of the retirement savings they need to support them in old age.

“Today’s report proposes a set of recommendations which would rebalance where our tax reliefs go, with the bottom 80 percent of earners gaining most from the reforms. This would help deliver greater financial fairness and boost retirement savings for those who need them most.”

Mr Haq added that, as highlighted in the report, the Government estimates it is spending £48billion on pension tax relief, but this is going “below the radar and has escaped reform”.

He told “The big problem we’re trying to address is that too many people aren’t saving enough for their pensions. The Government needs to direct more of these tax reliefs to encourage pension savings amongst those who need it most.”

A Treasury spokesperson said: “We want to encourage pension saving to help make sure people have what they need throughout retirement. That’s why, for the majority of savers, pension contributions are tax-free.

“Our reforms in 2010 to the annual allowance and lifetime allowance, which were necessary to deliver a fair system, only affect the wealthiest pension savers.”

The Treasury insisted Chancellor Jeremy Hunt keeps all aspects of the tax system under review as part of the annual Budget process and in the context of the wider public finances.

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