Tax relief cut not so deep

2 months ago

Since the announcement in the Spring Statement of the cut in basic rate Income Tax from 20% to 19% from April 2024, I have seen a number of articles about the hit to pension tax relief. Depending on the assumptions made in terms of level of contributions and number of years, figures as high as £28,000 being lost in tax relief over a lifetime have been quoted.

My view is that this is a very pessimistic stance to take – and an interesting slant that a cut to basic rate tax can be construed as bad for basic rate taxpayers.

The majority of advised clients will be higher or additional rate taxpayers, and in practice pension contributions are likely to be restricted by the annual allowance rather than by earnings. For this group, where the entire contribution falls within the higher rate band (or above), then there is no loss in tax relief – but there will still be a slight redistribution for those using a relief at source scheme.

When basic rate moves to 19%, a higher rate taxpayer will still be able to claim tax relief on the full amount (assuming no other changes to pension tax relief in the interim) – the difference will be that instead of 20% going to the pension and 20% to them personally, the split will move to 19%/21%. More money in their hand, slightly less in their pension.

For basic rate taxpayers there will be no need for their pension to lose out unless they pay a regular fixed amount and choose not to amend it. Under current rates a basic rate taxpayer receives £80 in their pocket for every £100 they earn above their personal allowance (ignoring NI as that’s a whole different matter for discussion another day). If they put that £80 into a pension it is grossed back up to £100. After April 2024 they will get £81 for every £100, if they choose to put that £81 into a pension then it will still be grossed up to £100. Yes, they’ve “lost” £1 of tax relief – but do you really lose what you’ve never had i.e. if you didn’t pay that extra tax in the first place? Unlike higher rate taxpayers, it is likely that earnings, not annual allowance, will be the restricting factor on contribution levels – so the extra can nearly always be paid in.

Of course, a large portion of the population are only saving the minimum under auto enrolment. For these people nothing will really change. Assuming their employer pays in the minimum 3% of qualifying earnings, the employee pays 5%. Currently this is made up of 4% net pay and 1% tax relief: from April 2024 this will be 4.05% of net pay and 0.95% tax relief – not quite so catchy for the graphics or as easy to explain.

My point is basic rate taxpayers aren’t worse off – they have the choice of whether the put the 1% tax saving in their pocket or in their pension – and in auto enrolment it will automatically go to the pension.

Those in net pay schemes don’t lose out either. As contributions are made gross to the pension scheme before Income Tax is deducted there will be no change to the amount received by the scheme, whatever rate of tax you pay.

The only real loss of tax relief will be for those that don’t pay tax in the first place. Those non-earners can pay in £2,880 now and it will be grossed up to £3,600. From 2024 it will cost them £2,916 – an additional £36 – to get the same amount in their pension.

What it does do is make saving into a LISA with its 25% bonus (the equivalent of 20% tax relief) a more attractive option for basic rate taxpayers that are young enough, as long as they are not giving up their valuable employer pension contribution.

This article was previously published by New Model Adviser

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Lisa Webster

Lisa Webster

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Senior Technical Consultant

Lisa is an Economics graduate who has been in the financial services industry since 2003. Prior to joining AJ Bell in 2014 she spent nine years working in senior technical and consultancy roles at a major SIPP and SSAS provider. Lisa is part of our Technical Team, responsible for providing regulatory and technical analysis to the business and outside world. She is also a regular speaker at adviser events.

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