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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