Simplifying pension tax relief? – Budget 2020
There was an article in yesterday’s FT weekend under the headline ‘Javid eyes tax raid on high-earners’.
So what is our favourite ‘low tax guy’ up to?
The main thread of this article was that a review (and restriction) of the tax relief in respect of pension contributions seems in the offing. Any such changes would be announced in the Budget on 11 March.
The first point to make is this issue comes up every single Budget cycle. Like a stopped clock, this prediction will be right one day!
However, pension tax relief, it is reported, costs £40bn per annum. This is almost 15 times the amount that Entrepreneurs Relief (“ER”) costs (£2.7bn) a relief which has been condemned for its cost (clearly it benefits a narrower cross section of society).
Like ER, pension tax relief is seen as benefitting those who don’t need the financial leg up the most.
Pension contributions tax relief – where are we?
This is because tax relief is given at the individuals prevailing rate of tax. If one is a basic rate taxpayers then tax relief on the contributions is 20% and if one is a higher rate taxpayer, then one gets tax relief at 40%.
At present, a personal pension contribution is grossed up by the basic rate band and added to the investment fund which provides basic rate tax relief. For higher rate (and additional rate relief) the various thresholds are extended by the gross contribution.
For work-based schemes, the contribution is deducted from salary paid through payroll with only the net amount subject to tax and NIC.
There are a whole host of breaks on (effectively) higher rate tax payers, including the annual allowance (which caps the annual amount of tax relief on contributions) and the lifetime allowance which provides an overall lifetime cap on the amount of relief available.
In terms of the complexity of the pension tax system, this is the thin end of the wedge. I remember (when I wer’ a lad) that when this legislation was being introduced it was under the strapline ‘pension simplification’.
That’s a laugh.
When one throws in the rules around drawing benefits, death benefits and what is and what is not an authorised payment it is difficult to consider how it would be possible to come up with anything more complex.
As such, I welcome any measures that would make the system simpler and more intuitive.
It strikes me that there is probably an easier way to deal with the system of tax relief. And, as the Government draftsman is overworked and welcomes the odd cut and paste (don’t we all), it might be useful if one draw some inspiration from an existing tax relief.
Under the Enterprise Investment Scheme (“EIS”), a regime to promote investment in growth companies, one is allowed a tax credit that is equal to 30% of your investment up to £1m. For instance, if one puts in £100k, then one gets £30k which is deducted from the tax liability right at the bottom of the tax computation.
Could something similar could work for pension schemes?
Under this system the Government would simply need to set the appropriate percentage rate for the year and the maximum amount of investment. One could then do away with the complexities of the annual allowance and the lifetime allowance.
This would work quite simply for personal pension contributions, but it would also need to capable of being administered through payroll as well. This does not seem to be beyond the wit of man.
Of course, under the current system, if someone contributes £100 to their SIPP then the Government adds a £25 bonus (ie this is how basic rate relief is provided).
Clearly, the 30% rate would provide compensation for this reduced fund. The same rate would reduce the burden placed on the Government to pony up the higher rate tax relief.
Clearly, my thoughts are unfunded and without this my idea is for the birds. However, if the cap was set at say 30% of £100,000 then this would seem to represent a significant saving.
I’ll leave the problem of transitional rules to someone else!
If you have any queries about this article, or tax matters generally, then please do get in touch.