Osborne scraps pension tax relief changes

Chris Torney / 08 March 2016

Chancellor George Osborne has revealed that he no longer plans to reform the way tax relief is applied to pensions in the upcoming Budget.

Over recent months, Treasury officials had made it clear that the government was likely to amend the current system of incentives to save into a pension. 

At present, all pension contributions benefit from tax relief: this is worth at least 20%, and for higher- and top-rate taxpayers, 40% or 45% respectively.

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How tax relief works

In practice this means that every £80 saved into a pension is topped up to £100 by the state. Higher-rate taxpayers can then claim a further £20 through the self-assessment system, and top-rate taxpayers get an extra £25.

It is thought that the Chancellor was planning to use this year's Budget either to restrict relief to 20% or to introduce a new universal flat rate of around 25% or 30%. 

The government spends billions of pounds a year on pension tax relief, and many campaigners think it is unfair that above-average earners benefit to such a great degree from the system.

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Change of heart

But last weekend, Osborne told newspapers that he had decided not to go ahead with the reforms this month. 

Reports suggest he had come under pressure from Tory backbenchers, as well as from the pensions minister Baroness Altmann to reverse or at least delay the planned policy.

Another reason for the U-turn could be that the Chancellor is unwilling to add further complication to the pensions system given the large number of significant changes that have been introduced recently.

These include a raising of the state pension age, the introduction of the auto-enrolment workplace pension programme, new rules on taking retirement income and, from April, a new state pension system.

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Future prospects

It is thought that many savers in higher income-tax brackets have been making extra pension contributions over recent weeks in order to benefit from the currently higher rates of tax relief. But the Chancellor’s change of heart means that this action may turn out to have been unnecessary.

Nonetheless, many experts believe that this latest announcement merely represents a delay in reform of the tax relief system and that changes are likely to be made before the end of the current parliament in 2020.

There has been speculation also that a future cut in the rate of tax relief for higher earners could be offset by a change in the way pension income is taxed. At present, income tax applies to money taken from a pension (aside from the 25% tax-free lump sum that savers are entitled to).

But if relief is to be restricted, the Government may at the same time decide to make all pension withdrawals tax-free.

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