The number of well-off savers maxing out their £60,000 annual pension contribution has shot up ahead of the Budget, according to two top investing platforms.
A 71 per cent increase in clients using their full annual allowance in the current tax year is reported by Hargreaves Lansdown, and a 64 per cent jump is cited by Interactive Investor.
Neither firm would reveal the precise number involved, but both assured This is Money it wasn’t just a small handful of their very wealthy clients, but a meaningful cohort of pension investors.
Pension tax relief: Are concerns about a major revamp overdone? Find out why Chancellor might decide against the move below…
The annual allowance is the standard amount you can put in your pension every year and qualify for tax relief on what you saved.
It is currently £60,000, or up to 100 per cent of your annual earnings if they are lower than this. The annual allowance includes your own and your employer’s contributions into a pension, and the tax relief itself.
That £60,000 limit came into play in the 2023/24 financial year. From 2016/17 until that time, the limit was a lower £40,000.
Speculation the Government will overhaul pension tax relief in a way that penalises higher earners in the Budget on 30 October is likely to be a main driver of a rise in contributions in recent months.
However, concerns about a move to flat rate pension tax relief could be overdone as it would be fiendishly complicated.
Below, pension experts outline how arduous the task would be, and how controversial.
This is Money’s publisher Simon Lambert argues a pension tax relief raid would rob younger workers of a benefit from which older generations have profited.
Some savers are piling cash into pensions…
Pension savers are using a window of opportunity to increase contributions ahead of the Budget, according to Hargreaves’ head of personal finance Sarah Coles.
This is in response to rumours that Chancellor Rachel Reeves might have the annual allowance or pension tax relief in her sights, plus a way of protecting wealth against capital gains tax, dividend tax and inheritance tax bills, she explains.
‘As a higher or additional rate taxpayer, you’re benefiting enormously from tax relief that would see a £60,000 contribution cost just £36,000 for a higher rate taxpayer and £33,000 for someone paying additional rate tax.
‘If you haven’t been in a position to contribute much to a pension in recent years, then you can scoop up any remaining allowances from the previous three years through carry forward.
‘This has the potential to turbo charge your contribution up to a maximum of £200,000 this tax year, provided you earn at least that much per year.’
Coles says that people with modest rather than enormous sums to put away will also benefit from tax relief, adding that time in the market will see it grow and build your retirement resilience.
Others are withdrawing tax-free cash – perhaps over-hastily
Myron Jobson, senior personal finance analyst at Interactive Investor, says: ‘With the swirling rumours of changes to the UK pension regime, it’s understandable that many might feel a bit jittery about the future of their retirement savings.
‘However, it’s crucial not to let speculation drive hasty and irreversible decisions when it comes to your pension.’
Interactive has also seen a 58 per cent jump in the volume of tax-free cash withdrawn from pensions in the first half of September, compared with the same period last year.
This is likely to be in response to rumours the Government could change the rules on tax-free cash. But savers are being warned this is among the pre-Budget moves that could come back to bite you.
Jobson says: ‘Taking a tax-free lump sum, of up to 25 per cent, reduces the amount of money in your pension pot, which will decrease the amount available for your retirement income.
‘The remaining 75 per cent of your pension pot, when accessed, would be subject to income tax at your marginal rate, meaning any withdrawals or annuities purchased with the remaining pension could be taxed as regular income.
‘By taking out a big lump sum, you also reduce the amount that could potentially grow with investment returns, which could have a profound impact on the total value of your pension pot over time.’
Will the Chancellor take axe to pension tax relief for higher earners?
Pension tax relief rebates any tax you would have paid on your contributions into your pot, to put you back where you started.
The present system is tilted in favour of the better off because they pay more tax.
Speculation that Chancellor Rachel Reeves will consider a pension tax overhaul – including a flat rate – has prompted warnings of a potential hit to six million higher earners’ pensions.
Other downsides being aired are the impact on economic growth if they invested less, a clash with salary sacrifice contributions, and complications with final salary pensions – which could even spark public sector strikes.
Calum Cooper: Salary sacrifice schemes, where employees trade part of their salary for pension contributions and tax savings, might need complex adjustments
We asked three top pension experts to explain the challenges of changing the long-established system, and whether they could be overcome.
Flat rate tax relief would require overhaul of entire pension system
‘Flat-rate tax relief on pensions may sound simple, but it’s far from it,’ says Calum Cooper, head of pension policy innovation, Hymans Robertson.
‘Currently, pension tax relief is based on income tax bands, with higher earners getting more. Moving to a flat rate of, say, 25 per cent, would be a big change and would take time to get right.
‘For example, salary sacrifice schemes, where employees trade part of their salary for pension contributions and tax savings, might need complex adjustments to align with the new rate.
‘This would require new administrative arrangements for employers and workers.’
Cooper says defined benefit pensions, which promise a set payout in retirement and are widely used in the public sector, would also be affected.
‘These schemes use detailed calculations to value extra pension earned for tax relief,’ he explains.
‘A flat-rate system would add complexity and fairness challenges between higher and lower earners in the same scheme. Introduced bluntly, it might lead to large tax bills for higher earning public sector employees.’
Cooper says flat rate pension tax relief would require an overhaul of the entire pension system including payroll, creating administrative headaches for businesses and pension providers.
‘These challenges are just some of the reasons why the Government will be thinking hard about whether to introduce flat-rate pension tax relief.’
Working out flat rate employer contributions into defined benefit pensions would be tough
A flat rate of relief would have to apply to employer pension contributions and that would involve complex valuations, says Quilter’s head of retirement policy Jon Greer.
Jon Greer: A flat rate of relief would have to apply to employer pension contributions too
‘If a flat rate of relief only applied to employee contributions higher rate tax payers could continue to get 40 per cent relief (or more) by giving up salary in exchange for higher employer contributions,’ he explains.
‘Basic rate taxpayers would not then benefit to the extent those advocating flat rate relief would want.’
He explains that could mean some form of tax would have to apply to employer contributions, which would be administratively onerous and create a problem for defined benefit schemes -including public sector ones – because how would you value those employer contributions.
‘In defined contribution schemes it’s easy to identify the amount of employer pension contributions.
‘But in defined benefit schemes the employer pension contribution reflects the cost of new benefits for the membership (and for funded defined benefit schemes possibly some deficit contributions) and aren’t always identified for individual members.’
Greer predicts there would be little understanding or trust in whatever method of calculation was devised for a tax charge on employer contributions into pensions.
‘Of course the Government could look to ban salary sacrifice to avoid the above complexities,’ he says. ‘The issue would then be how to enforce that.’
He says it could be done for existing employees, though they would see the cost of making pension contributions increase, much to their annoyance.
Meanwhile, employers could offer new staff a higher employer pension contribution and slightly lower salary.
Pension overhaul could cause strife with public sector unions
HMRC has been assessing the amount of tax relief paid each tax year and what percentage of the population receive it, according to Gary Smith, partner in financial planning at Evelyn Partners.
It is being rumoured higher and additional rate tax reliefs could be scrapped and replaced by a slightly increased tax relief for all, he says.
Gary Smith: The Chancellor could leave public sector schemes untouched, but this is unlikely to go down well with the public – or the basic taxpayers who are members
Smith explains doing this would be very complex, but trying to avoid the difficulties could mean ending up with a two-tier system where employees in some schemes continued getting different levels of tax relief put into their pensions, while others moved to a flat rate.
‘The Chancellor could opt to leave the public sector schemes untouched, but this is unlikely to go down well with the general public,’ he says.
‘They would view it as being very unfair that those members continue to receive higher rate relief, when everyone else does not.’
Also, basic rate taxpayers in those same schemes would lose out because they would carry on getting the same tax relief as before, rather the new higher flat rate received by other workers elsewger=.
On the other hand, changing public sector pensions to accommodate flat rate relief would be costly and an administrative burden, points out Smith.
And in that situation, it would instead be the workers who currently get higher and additional rate tax relief who would lose out on valuable contributions to their pensions.
He warns that either scenario could lead to public sector strikes.
‘Any such change would also likely be challenged by unions as either basic rate, or higher and additional rate members would be negatively impacted, regardless of which option is taken.’
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