By Dale Critchley, Policy Manager, Aviva
At Aviva we’ve long advocated a flat rate of tax relief to redistribute the relief that’s currently skewed toward those who earn the most and benefit from the biggest pension contributions. But change won’t be easy to implement politically or practically.
The report makes the point that many people don’t understand tax relief. I would go further and say most people don’t understand it, including people working in the industry and representing us in parliament.
Lots of people realise they get tax relief added to their contributions. But ask what tax relief is paid on employer contributions and a good number, including those in the industry, will confidently tell you that “you only get tax relief on employee contributions”, or “employers get corporation tax relief”.
This is a problem because most of the tax relief actually goes on employer contributions. There are two reasons for this:
1. Employer contributions are exempt from National Insurance Contributions (NICs) as well as income tax. Relief on employer contributions for basic, higher and additional rate tax payers is 45.8%, 55.8% and 60.8% respectively. 13.8% of this goes to employers because of the NICs exemption.
2. Automatic enrolment minimum schemes excepted, employer contributions are generally higher than employee contributions, and are highest in Defined Benefit (DB) schemes (DB accounts for 70% or more of HMRCs tax relief bill).
It’s worth busting the “corporation tax relief” myth too. This isn’t considered in HMRC’s calculations because the assumption in calculating the cost of tax relief is that money spent on pensions would be paid as wages, which are also business expenses, rather than banked as profits.
The problem for anyone trying to change the rate of relief is that higher and additional rate tax payers will need to pay tax on total pension contributions, not just their own. A flat rate of 25% relief means a marginal tax rate of 15% for higher rate tax payers. Paying 15% tax on something you don’t get to benefit from until you’re in your mid-50s or 60’s is unlikely to be a vote winner.
It won’t be straightforward for employers or pension administrators either. PAYE complexity will be a problem for net pay arrangement schemes, while defined benefit schemes may see more administration issues.
The valuation of accrual x16 is fine when few members are impacted and little attention is paid to just how good a deal this is for older workers. If every higher rate tax payer in both DB and Defined Contribution schemes is paying tax on every £ of benefit accrued, greater scrutiny of the valuation methodology is almost certain.
We have to get best value from tax relief, but we need to make sure the debate is well informed if we are to come up with a workable solution that has broad based support.
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