You will have been hard pressed to flick through the financial pages of a national newspaper in the past couple of weeks without reading rumours that the Treasury is considering a tax raid on pensions to help pay for the costs of the COVID crisis.

This is by no means the first time such speculation has arisen, but usually it rears its head before the Budget, when the Treasury likes to fly a few policy kites to gauge public reaction.

There may be some substance to the rumours this time. But just because the Treasury is considering a policy, it doesn’t mean it will see the light of day, and there remain many reasons why raising large sums of money for the Exchequer from the pensions system is a non-starter.

EQUALISING TAX RELIEF?

The most headline-grabbing reform said to be under consideration is equalising the rate of tax relief provided to basic rate and higher rate taxpayers.

Currently savers get pension tax relief at their marginal rate of tax, so 20% for basic rate and 40% for higher rate taxpayers.

Analysis carried out by the Pensions Policy Institute suggested that equalising these rates at 30% would cost the Government money, while a rate of 25% might save between £2 billion and £3 billion a year, and a 20% rate would save around £6 billion to £8 billion a year. So, if the plan is to raise funds for the Treasury, the flat rate would need to be set well below 30%, and perhaps as low as 20%.

HOW YOU COULD BE AFFECTED

Such huge savings would clearly come at a cost to individuals. A 35-year-old higher-rate taxpayer earning £60,000 a year and paying 4% of salary into a pension until age 67 could miss out on £50,000 of retirement income, if a flat rate of 20%  was introduced.

Those earning more or making larger contributions would face an even bigger hit to their plans.

That’s not going to play well with the millions of higher rate taxpayers across the country, or their families, many of whom will be Conservative voters.

Conservative backbenchers are already twitchy about losing core supporters in the wake of the Chesham and Amersham by-election result, and the Government will be under no illusion that a tax grab on the pensions of Middle England will simply sail through Parliament unopposed.

BAD NEWS FOR HIGHER EARNERS?

But there’s even a bigger fly in the ointment for reform of pension tax relief, and that’s the way guaranteed defined benefit pensions work, with most of these now being in the public sector.

To apply a flat rate of relief to these pensions, a tax charge would need to be handed to higher earning employees.

Doctors and senior NHS staff, who have been on the front line dealing with the pandemic, would likely end up with tax bills running into thousands of pounds as a result.

That doesn’t sound like a battle the Government would want to take on, considering the likely reaction from both the press and the public.

LIFETIME ALLOWANCE CUT?

There are other reforms which might be under the microscope too. A reduction in the Lifetime Allowance, and taxing employer pension contributions, have also been mooted.

While at first glance such measures might sound more palatable, they would still represent an attack on people’s pensions, which will only be as lucrative for the Exchequer as it is painful for savers.

The Government has backed itself into a corner by ruling out increases to income tax, National Insurance and VAT in its election manifesto.

But if the Treasury’s bean counters really are greedily looking at the pension system with pound signs in their eyes, there’s a fundamental equation which they’ll keep banging their heads up against.

The more money they want to save, the more people’s pensions they would have to raid, and the bigger the backlash would be. While reform isn’t impossible, it would be an uphill battle for a Government that’s already got a lot on its plate.

LISTEN TO TOM SELBY DISCUSS THE RUMOURS ABOUT PENSION TAX CHANGES

The 25 June episode of Shares and AJ Bell’s Money & Markets podcast features AJ Bell’s senior analyst Tom Selby discussing the implications of the rumoured changes to the pensions system.

Click here to listen to the podcast, or go to Spotify, Amazon Music or Podbean to hear this episode and more. The segment can be found at 33:55 minutes into the episode.

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