High earners lose 40% tax relief

Pension pot

The government’s penchant for tweaking the pension rules as a way of bolstering the Treasury’s coffers unsurprisingly made an appearance in today’s Budget.

Alistair Darling’s second Budget suggested that Labour’s ‘recession rescue plan’ was to make high earners stump up the funds to plug the spiralling public deficit, and to tinker with the already-much-tinkered-with pensions system, arguably an easier and a politically safer area to play with than, say, income tax or VAT.

So, as a result, people earning more than £150,000 a year will see the tax relief on pension contributions gradually reduced. For those earning between £150,000 and £180,000, the relief will gradually be cut from the current 40% to 20%.

Those with a £180,000 plus salary will only receive 20% tax relief on any personal contribution to a pension scheme.

The move will net the exchequer £200 million in savings when it comes into force in the tax year 2011-12.

"Those on highest incomes benefit disproportionately from this relief, and the personal tax changes announced in this Budget would increase the value of the reliefs given to individuals with the highest incomes," Darling told the Commons during his Budget speech. "This would exacerbate the current situation whereby in 2008-09 individuals with income over £150,000 represented 1.5% of pensions savers, yet received a quarter of all tax relief on contributions (£6.1 billion)."

However, the pensions industry came out in force to condemn Darling’s actions.

Rachel Vahey, head of pensions development at insurance group Aegon, says it undermines previous government pledges to promote long-term pension saving. "That major overhaul of the pensions tax rule was meant to last 30 years rather than three years," she blasted.

Louise Somerset, tax director at RBC Wealth Management, says the announcement is a "short-term solution with serious long-term consequences" - and will discourage pension saving.

According to Martin Palmer, head of corporate pensions marketing at Friends Provident, the attack on pension tax relief sends the wrong message. He also argues that while higher earners will soon have to receive basic-rate tax relief on the contributions they pay in, when they come to take their pension they will "no doubt have to pay the higher rate of tax".

Standard Life calculates the move will affect 291,000 people. If someone earning more than £150,000 paid £100,000 into their pension, this currently costs £60,000 (due to 40% tax relief).

But in 2011 it will cost £80,000 as only basic rate relief is added.

Since the change won’t happen until 2011, the government was quick to close the potential loophole of high earners stuffing as much money as they can into their pension during the next two years. Darling said individuals were allowed to receive tax relief at the higher rate on either a £20,000 contribution, or their normal pattern of contributions, whichever is higher, between now and 2011.

This year’s Finance Bill will include legislation on exactly how pension contributions will be policed during this timeframe.