Will he or won’t he? The big pension tax relief question

Until very recently, there was considerable speculation that the Chancellor, in his Budget on 11 March, would announce a radical shake-up of pensions tax relief.

The latest headlines, which follow a change in Chancellor, suggest that the rumoured shake-up will no longer happen.

Of course, we will not know for sure until the afternoon of 11 March and, at very least, some tinkering with pensions and tax relief seems inevitable, even if it is just an attempt at fixing well-publicised issues impacting the NHS (where a wide range of NHS staff including GPs and Consultants, not just high earners, are affected by the annual allowance on pension tax relief).

In this blog, we look at the current system for pensions tax relief and some of the options for reform.

The current system and possible alternatives – EET, TEE, ETE, ETT (nothing to do with Latin verbs!)

The current common tax regime for approved / registered pension schemes took over 50 years to achieve (1920–1970) and has now been substantively in place for the same length of time (1970–2020).

Currently, contributions to pensions are exempt from tax when they are made but pension benefits are taxed when they are paid out to the individual. Employer pension contributions are also not subject to employer or employee National Insurance Contributions, and investments grow largely tax-free.

The pensions tax relief system, which is not unique to the UK, is commonly referred to as Exempt, Exempt, Taxed, or ‘EET’. After tax relief, £1 of pension costs a basic rate taxpayer 80p, a higher rate taxpayer 60p and an additional rate taxpayer 55p.

According to HMRC statistics, the cost of pension tax and National Insurance Contributions (NICs) relief (net of tax received on pension income) was £35,400 million in 2017/18. It has gone up and down over recent tax years but consistently exceeded £30 billion. It has also been observed that around 40% of the amount spent on pensions tax relief each year goes to the top 10% of earners.

So, if the regime we have now is considered too expensive or inequitable, what about alternatives to the EET system?

In terms of serious contenders, it seems likely that any change would be to either –

• a move to a tax, exempt, exempt (TEE) system (the system used for individual savings accounts or ISAs); or
• the introduction of a single rate of tax relief on pension contributions.

Another possibility (which comes around every year) is changes to the rules on tax-free cash on retirement. The reason that this probably never happens is that, unlike some of the other changes to pensions tax reliefs, tax-free cash is understood and removal of it, or even a cap, would not go down well with the electorate; especially not those who have factored the current system into their retirement planning – moving goalposts is never a popular decision.

Investment returns could also be taxed (e.g. an ETE or ETT system). Such a change is, however, complex and there are no real precedents for it in terms of pension tax relief systems in other countries.

Will he, or won’t he?

According to The Times on 24 February, the Chancellor, Rishi Sunak, is expected to drop plans to cut pensions tax relief for higher earners. According to reports, Tory MPs are opposed to any such move. There are also concerns that it would be too complex to implement at such short notice and, let’s be honest, many high earners may be Tory voters too.

However, there have been unexpected pension announcements in the Budget before, such as the introduction of pension freedoms in 2015. So, whilst it seems likely that any change will be confined to ‘tinkering at the edges’ as part of a response to the NHS issues, more material changes cannot be ruled out completely.

Moreover, it seems clear that fundamental reform of pensions tax relief is still very much on the government radar and further far-reaching change is more a matter of ‘when’ rather than ‘if’.