By Richard Johnstone | 15 July 2013
The current system of pension tax reliefs benefits higher earners disproportionately, a report examining the current system by the Pensions Policy Institute has found.
Today’s Tax relief for pension saving in the UK found there was ‘limited evidence’ that the £23.7bn paid in reliefs in the 2010/11 tax year had encouraged people to save.
Among the reasons for this, the report said that understanding of the tax treatment of pension contributions is low.
However, the PPI found that, as reliefs are based on the tax rates paid by individuals, the current system of reliefs had disadvantaged the lower paid. Although people who pay the basic rate of tax – earning up to £34,371 – make around half of total pension contributions, they only receive around 30% of the total spending on reliefs. By contrast, higher rate taxpayers, who account for 40% of total contributions, actually receive around half of the total spending on tax reliefs. Additional rate taxpayers, who earn at least £150,000 and pay the top 45 pence rate of tax, receive 17% of all tax relief but make only 95 of total contributions.
PPI director Chris Curry said the current system is ‘poorly understood and there is little evidence that it encourages pension saving among low and medium earners’.
He added: ‘Even with pension saving boosted for lower earners by automatic enrolment, basic rate taxpayers are estimated to make 50% of pension contributions, but receive only 30% of pension tax relief on contributions.
Curry said that ‘radical alternatives’ to the current regime, such as a single rate of relief applied to all pension contributions, could spread the advantages more evenly.
‘A tax relief rate of 30% could have a cost similar to the current system. If presented clearly, a 30% rate could give a larger incentive to basic rate taxpayers to save, while still leaving pension saving at least tax neutral for higher rate taxpayers.’
However, he warned that implementation of such a system ‘would be far from straightforward’, with significant changes in the administration of pension contributions required.
Trades Union Congress general secretary Frances O'Grady said: ‘The PPI report also highlights a serious flaw in the current tax relief system, with many people receiving relief at the higher or additional rate, but then becoming basic rate taxpayers in retirement.’
The TUC would back a flat rate for tax relief, set at 30% of contributions, she added. ‘This would transfer some of the benefits from the very wealthy to lower and middle income earners without any additional cost to the Exchequer.’
