Is the Government about to scrap higher-rate pension tax relief?


You may have read reports recently suggesting the Government is considering reforms to pension tax relief at the Budget on 11th March. We're here to separate pension fact from fiction.



How does pension tax relief work at the moment?

When you pay money into a pension it is free from income tax, with total annual contributions (including tax relief) capped for most people at £40,000. This relief is provided so you aren’t taxed twice on the same money, as 75% of withdrawals from age 55 are subject to income tax (with 25% available tax-free).

The way you receive this tax relief will depend on the type of scheme you pay into. If your contributions are paid from your gross salary – i.e. your pre-tax pay – you should receive tax relief automatically, provided your earnings are above the £12,500 personal allowance. This includes ‘salary sacrifice’ and ‘net pay’ workplace pension arrangements.

If you pay into a pension such as a SIPP from your net salary – i.e. your post-tax pay – your scheme will add basic-rate tax relief (20%) automatically. For example, if you pay £80 into a SIPP your provider will add £20, taking the total contribution to £100.

If you are a higher (40%) or additional (45%) rate taxpayer you can then claim your extra tax relief entitlement via self-assessment. This will be deducted from the income tax you pay in the following tax year.

So in the above example, a higher-rate taxpayer could claim back an extra £20 in addition to the £20 added via basic-rate relief – meaning £100 in a pension only costs £60. An additional-rate taxpayer could claim back £5 more, meaning £100 in a pension costs £55.

What is going to happen at the Budget?

In the 10 years I have been writing about pensions there has barely been a Budget where stories haven’t emerged suggesting pension tax relief is facing the guillotine. This is unsurprising given the total cost of pension tax and national insurance relief is estimated at £35 billion a year.

This time round, reports suggest the ability to claim higher or additional-rate tax relief on pension contributions could be under threat. While there are no details of how this might work at the moment, such a move would make pension saving less attractive for higher and additional-rate taxpayers (i.e. those earning £50,000 or more).

You shouldn’t let this speculation derail your retirement planning strategy, however. The reality is that, like all areas of policy, pensions are subject to the whims of politicians. Rather than trying to second guess what lawmakers may or may not do based on newspaper speculation, focus on your goals and making the most of the tax benefits available where you can afford to.

What about the tax-free lump sum?

Just like pension tax relief, the 25% tax-free lump sum available from age 55 is the subject of perennial rumours it is about to be capped or removed altogether.

While such stories can be unnerving, you should avoid making any rash decisions which could end up costing you dear.

For example, anyone who decides to withdraw their entire pension in one go for fear of future changes to tax rules will likely pay more income tax than is necessary.

These articles are for information purposes only and are not a personal recommendation or advice.

ajbell_Tom_Selby's picture
Written by:
Tom Selby

Tom Selby is a Senior Analyst at AJ Bell. He is a multi-award-winning former financial journalist specialising in pensions and retirement issues. Tom has over five years' experience working at Money Marketing magazine, where he became the Head of News in 2014. He has a degree in economics from Newcastle University.