Every year, without fail, a story will rear its head about a government “raid” on your pension. Usually close to the Budget, or Autumn (now Spring) Statement, the cunning chancellor of the day is going to hack away at the incentives for saving into a pension, making them far less generous, in order to save billions for the public purse.
I usually know this not from the newspapers, but from the onslaught of emails from investment and pension companies screaming that my pension is under attack. And, of course, that I should be piling more money into my retirement pot to beat the wicked chancellor before he snatches away my benefits. There are, after all, juicy fees to collect with every new pound that drops into a pension.
In fairness, pension benefits have regularly been chipped away at over the years – but certainly not to the levels that these firms make out.
The lifetime allowance – the total amount you can save into a pension – has been chopped from a high of £1.8m in 2011/12 to as low as £1m in 2017/18, although it now rises with inflation each year and currently stands at £1.03m.
The annual allowance, the maximum you can pay into a pension each year and earn tax relief, has also been cut dramatically. In 2010/11, it was an incredible £255,000. It now sits at £40,000.
But how does this save the government money?
When you save into a pension, the government likes to give you a bonus as a way of rewarding you for saving for your future. This comes in the form of tax relief. Some of your money that you would have paid in tax on your earnings goes into your pension pot rather than to the government.
The idea is that you don’t get taxed on the way into saving for your retirement, but you do get taxed when you finally withdraw money from your pot, so the government can recoup its outlay.
The amount of relief you get is based on your income tax rate. So, if you’re a basic-rate taxpayer in Scotland you get 20 per cent tax relief. Say you were to contribute £100 from your salary into your pension, it would actually only cost you £80. The government adds an extra £20 on top – what it would have taken in tax from £100 of your salary. Starter rate taxpayers, who pay 19 per cent income tax, get 20 per cent pension tax relief.
When allowances are cut, less can be invested into a pension, which means the government doesn’t have to fork out as much in tax relief. But there are other advantages. Pension contributions are invested, and grow free of income tax, dividend tax and capital gains tax. That’s all money the government is missing out on, so if less is going into a pension and being invested elsewhere, it gives the government the opportunity to collect more taxes.
The one thing which gets people hopping up and down, though, is the potential for cuts to the actual level of tax relief.
The amount paid out is enormous. According to HMRC figures, pension tax relief cost the government £38.6bn in 2016/17. In January this year, HMRC said it expected this figure to rise to £41bn in 2017/18.
The most explicit indication that this could be up for grabs came three years ago, when then-Chancellor George Osborne launched a consultation called “Strengthening the incentive to save”. In this, there were proposals to level off tax relief so that everyone – no matter how much income tax you paid – got the same flat rate of relief. There were other radical ideas, such as doing away with tax relief altogether, and instead making pension withdrawals tax free, similar to an Isa. Indeed, the Lifetime Isa, which pays a bonus on contributions that can eventually be used to either buy your first home or for retirement, is a prototype for such a model.
This consultation – and any subsequent changes to pension tax relief – was ultimately kicked into the long grass, but I suspect those warning emails I mentioned earlier are about to start pouring in again.
A couple of weeks ago, the influential Treasury Committee published a wide-ranging report which, among many things, advocated for reform to tax relief. This cross-party group flagged that in 2015/16, 52 per cent of the total income tax relief paid on pension contributions went to individuals earning £50,000 or above, up slightly from 49 per cent in 2010/11 – essentially, that the current system rewards the better off and doesn’t help those that are in greater need of a healthy retirement pot.
Many of the witnesses the committee spoke to argued that “tax relief is not an effective or well-targeted way of incentivising saving into pensions”, despite the huge cost to the taxpayer. Baroness Ros Altmann, a former pensions minister, said that even the term ‘tax relief’ may confuse people into thinking they’ll be taxed, rather than the actual “free money” they get from pension saving.
The committee as good as gave the government the nudge to pursue the kind of sweeping reforms that were proposed in 2015. In the meantime, it recommended that the lifetime allowance was scrapped, the annual allowance was cut and that the government moved to a flat rate of tax relief – pretty radical in and of itself.
Another former pensions minister, Sir Steve Webb, has warned against any changes, arguing that pension savers need stability to properly plan for the future. But after a few years of relative silence from lawmakers on the issue, I suspect that tax relief reform is going to be in play when we to come to this year’s Budget in a few months’ time.
My inbox is already quivering at the thought of it.
Gareth Shaw is head of Which? Money Online