Could new pension changes include flat-rate tax relief?

New pension changes took effect last month, but one suggestion that has been discussed over the past year yet hasn’t been implemented is flat-rate tax relief. Currently tax relief is applied at an individual’s marginal rate, so a basic-rate taxpayer receives 20% while a higher-rate taxpayer receives 40%. However, pensions minister Steve Webb has suggested a flat-rate of tax relief instead – but is this feasible?

What is tax relief?

When a contribution is made to a pension, the government puts back the tax it would receive from income, boosting the size of the savings. If a basic-rate taxpayer made an £80 payment to a savings account, the total value would be £80; however, if they put the £80 into a pension, the tax relief would be £20, boosting the fund to £100. This is part of the reason pensions are such efficient savings vehicles.

How is it applied?

Everyone receives 20% tax relief on pension contributions – even people not in employment, including children. Higher- and additional-rate taxpayers pay 40% and 45% income tax, respectively, and so receive a higher rate of tax relief than basic-rate taxpayers. This system means that tax relief is applied at either 20%, 40% or 45%. 

What would single-rate tax relief mean?

single rate of tax relief would mean that everyone receives the same percentage regardless of their earnings. Steve Webb’s suggestion is for a rate of 33% for everyone, which would mean higher earners receive less but basic-rate taxpayers would receive more. 

Why would it be implemented?

There are a number of reasons to consider it, primarily to encourage more people to save into a pension but also to create a more equal system that ismore easily understood than the current one. Although higher-rate taxpayers would receive a lower amount than they do now, 33% is still more than is applied elsewhere so it is unlikely the change would deter wealthier people from using a pension, especially with the other tax advantages such as exemption from inheritance tax.

Will it encourage saving into a pension?

There is a good chance that it will, as it’s effectively free money. With auto-enrolment encouraging more people to save into a pension , boosting the rate of tax relief for lower earners can provide a huge incentive to save. The uplift in tax relief could lead to a fund many thousands of pounds larger than under the current system.

The Liberal Democrats are the only party to include a flat rate of tax relief in their 2015 manifesto, but other parties have suggested further changes to pensions, so it could remain a topic regardless of who is in power after the election.

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The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section: https://www.portafina.co.uk/whats-new

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