From the blog: Politicians of all colours have gradually eroded the tax relief on pension contributions for high earners.
Does this matter? Well, yes it does – and not just for high earners.
The first important myth that needs to be dispelled is that higher-rate tax relief on pension contributions is grossly unfair and costs the government and taxpayers billions of pounds.
The basic underlying principle of the tax system in this country is that pension contributions are taxed when they are withdrawn by the individual rather than when they are deducted from that individual’s salary.
Thus, if a higher earner is paying higher-rate tax in retirement, higher-rate tax will already be deducted on withdrawals from their pension fund – even those contributions from early in the individual’s career that did not attract higher-rate relief.
If additional tax is deducted from pension contributions when they are taken from salary then that part of the individual’s salary will end up being taxed twice.
Go direct
If politicians want to apply an increased rate of tax to higher earners, it would be easier (and less costly) to apply that tax directly (via increased income tax) rather than taxing pension contributions, which will potentially affect many others as well as higher earners.
There are many problems with politicians’ proposals on taxing pension contributions.
If higher-earner taxation is adding to these administration costs, it is adding to the pressure to cut back or do something about excessive pension costs. This could hit all employees
First, it is creating significant complications when pensions are crying out for simplification.
Second, companies are fed up with the escalating costs of administering pensions.
If higher-earner taxation is adding to these administration costs, it is adding to the pressure to cut back or do something about excessive pension costs. This could hit all employees.
And third, as successive governments have reduced pension tax relief, they have eroded trust in the system.
Long-term saving, particularly into pensions, requires trust or individuals will simply put their money elsewhere.
Pensions desperately need a stable environment that is clearly understood and trusted. This is paramount because as a society we are not saving enough for retirement, particularly as longevity increases.
Driving away the bosses
In addition, higher earners are generally the decision-makers who hold the power in any company.
If politicians make rules that result in higher earners withdrawing from pensions altogether as they exceed the maximum tax benefit, then company leaders will not see the protection of good pensions for all as a priority. Consequently, everyone will suffer.
Finally, it is galling to see MPs proposing to reduce pension tax relief on higher earners given the generous relief on MPs’ pensions.
The tax limits in defined benefit pension schemes, now largely limited to the public sector, are almost twice as generous as for private sector defined contribution schemes.
If MPs were really concerned about being fair, they might look more reasonably at this clear inequality.
Duncan Howorth is chief executive officer at JLT Employee Benefits
