Cut to pension tax relief more of a scratch

One of the big headliners in the Spring Statement was the cut in basic rate income tax from 20% to 19% from April 2024. Good news you would think, but there were a few headlines that followed lamenting the damage to pension savings for low earners. The concern here being there could be significant reductions in pot sizes when tax relief is given at a lower rate – figures as high as £28,000 were quoted.

Personally I find it unlikely that a basic rate tax cut is bad news for any taxpayers, and to get to £28,000 “lost” there were some hefty contributions going in for a basic rate taxpayer for a very long time.

Looking at higher or additional rate taxpayers first – most advised clients – pension contributions will in practice be restricted by the annual allowance, not earnings, and where the entire contribution falls above the higher rate threshold there will be no loss in tax relief. To achieve £40,000 in the pension the net contribution will have to increase from £32,000 to £32,400 – but an extra £400 will be returned via self-assessment so it all comes out in the wash.

Turning to basic rate taxpayers, at the moment they get £80 in their pocket for every £100 they earn above the personal allowance (ignoring NI as that’s one for another day). If they put £80 into a pension they get their £20 back in tax relief to give £100 in the pension. When basic rate changes they will take home £81 for every £100 earned. They have the choice of sticking with paying in £80 into their pension – in which case the pension will end up with £98.76 and they keep the extra £1 to spend as they wish – or they pay in £81, leaving them with £100 in their pension and the same take-home earnings as now. The new rate may mean that they have lost out on some tax relief, but have they really “lost” if you can claim back the tax at whatever rate you paid? Unlike with higher rate taxpayers, basic rate taxpayers will usually have contributions restricted by earnings rather than any annual allowance, so the option of paying in the extra net income generated by the reduction in income tax will nearly always be available.

There may be a small reduction in pension pots for those that pay a fixed £ amount and choose not to amend it, but for those who pay a % of gross income, including under auto enrolment, and for anyone using net pay schemes there will be little impact.

The only real loss will be for those that don’t pay tax to start with. To get the £3,600 basic amount into a pension will cost £2,916 rather than the £2,880 we have now.

What the change does do is make Lifetime ISAs more attractive for basic rate taxpayers who are young enough to be eligible. The 25% bonus is the equivalent of 20% tax relief so when the rate is cut to 19% this will trump pensions as long as employer contributions are not being forfeited.

This article was previously published by Sipps Professional