Sunday, September 8, 2024

Treasury urges Chancellor to target pension savings of 6m middle-class workers

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The think tank said this “substantial increase” in tax would be shouldered almost exclusively by the top 20pc of earners, with the top 10pc facing an average hit of £4,300. The bottom 80pc, who largely receive basic income tax relief on pension contributions, would experience little to no change, the IFS said.

Sources familiar with the plans said moving to a flat 30pc rate of upfront relief could help to “level up” the savings landscape with more generous support for the majority of workers who would benefit by hundreds of pounds every year.

In 2018, when Ms Reeves was chairman of the business select committee, she wrote a 66-page document outlining a string of tax reforms, including limiting relief on pensions. She said: “Forty per cent of UK wealth is held in private pension funds. To combat this inequality, higher rate pensions contribution reliefs could be restricted.”

Two years earlier, in 2016, she proposed setting the relief at a flat rate of 33pc. The IFS has said a rate of 32pc would be roughly revenue neutral, although a freeze in the personal allowance is expected to drag millions of people into higher tax bands in the coming years.

Experts said a 30pc tax rate would force the Treasury to restrict salary sacrifice pension schemes, which currently provide a tax-efficient way for employers and employees to pay into a workplace pension.

The Treasury has also done detailed work on this proposal, which could raise up to £3bn a year. It has also conducted analysis on restricting relief on employee and employer National Insurance contributions.

However, Sir Steve Webb, a former pensions minister and partner at pension consultants LCP, said it would serve as a disincentive for employers to “do the right thing by penalising employers who contribute generously to workplace pensions”.

Research by the London School of Economics has also shown that the generosity of employer contributions for workplace pension schemes was the single biggest incentive for people to save, increasing the chance that someone will save into a pension by 71pc.

Sir Steve added that extending the restrictions to defined benefit schemes – which offer a guaranteed retirement income based on career earnings – would be hugely complex.

This is because most of the contributions to these schemes are made by the employer. Restricting relief to the basic rate, for example, would be the equivalent of a taxable benefit going to higher rate taxpayers. This could result in huge tax charges or reduced pensions in the event of an immediate tax charge.

Sir Steve said: “Giving everyone the same rate of tax relief on their pension contributions might seem fair, but it would be extremely complex to implement for the millions of workers in traditional salary-related pension schemes.  

“The bulk of contributions in such schemes comes from employers and are made without any deduction of tax. If higher earners lost higher rate tax relief they would potentially face a tax surcharge not just on their personal contributions but also on the contributions their employer makes directly to the scheme.  This bill could run into thousands of pounds a year in some cases.”

A Treasury spokesman said: “We have set out the need for economic stability and we have begun fixing the foundations so we can grow our economy and keep taxes, inflation and mortgages as low as possible.”

It comes as Ms Reeves told cabinet colleagues there will need to be “difficult decisions” on spending and taxation in her first Budget in the autumn.

The Chancellor issued the message as she prepares to sign off on above-inflation public sector pay rises in a statement to Parliament next week.

The approach, taken in part to avoid further strikes, has put the public finances under even more pressure as Labour attempts to decide how to pay for the move.

Ms Reeves was already juggling how to keep her campaign promises of not increasing tax on working people, avoiding “austerity” spending cuts and getting debt falling within five years.

Next week the Chancellor will go public about the scale of public spending pressures inherited by the Labour government after an internal audit.

But the Tories have claimed Labour is over-exaggerating how bad their economic inheritance is in order to create political space to increase taxes later this year.

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