Taxing pension contributions

I\’m not all that sure that I follow the logic here.

Many businessmen chose to take their pay package in two parts, with a relatively modest slice as income and the bulk going into their pension pot. This has been a popular, and legitimate way for people to reduce their tax liabilities, as well as a useful tool to encourage people to save for retirement. That is because the pension contributions, up to a maximum of £245,000 a year are entirely free from tax.

However, from 2011, the Treasury will, in effect, tax these contributions at a rate of 20 per cent for anyone earning over £150,000 a year.

Tax relief on pension contributions is limited to the basic rate of tax, yes, I get that.

But such tax relief hasn\’t been, at least I don\’t think it has been, a pure tax relief, has it? You don\’t get off scott free. Sure, you get to invest the money and save it without having paid tax. But when it comes time to take your pension you pay tax on the income you receive then, don\’t you?

So now these people will pay 20% income tax on the money they put into their pension….and standard income tax rates when they take the pension out again. And at the new 50% marginal rate….wait a minute, at the new 50% marginal rate it won\’t be taxed at 20%, will it? It\’ll be taxed at 30% (50% minus the 20% basic rate)….so they\’ll be facing a total of 80% marginal tax rate.

That\’s gotta hurt.

And we will no doubt see changes in behaviour at those sorts of tax rates, won\’t we?

11 comments on “Taxing pension contributions

  1. One of the long-standing absurdities of the pensions system is that people paying higher rate income tax on the top slice of their earnings get pension contributions tax relief at 40% even if they only just make it into the higher rate band.

    The effect is worsened because a higher-rate taxpayer who has some spare cash (whether from earned income or not) can dump it in to a pension plan and still get the income tax relief.

    It’s absurd because clearly, standard rate taxpayers on lower incomes subsidise those on higher incomes.

    A huge amount of good might have been started on Wednesday had the Chancellor just had the cojones to remove all higher rate tax reliefs on pensions contributions for everyone, effective immediately.

    If higher earners then decide to reduce pensions contributions and save in some other way (foregoing the basic rate relief) that’s up to them; the pensions industry could use a shake-up. If the money saved was used to increase the income tax threshold for low earners and remove some of the benefits poverty-trap, even better.

    Can’t see it happening though, as long as MPs are in the higher tax band.

  2. Somehow I just don’t see anyone doing any calculations come retirement time. The pot will be taxed at whatever band it is in regardless of what tax was paid previously.

    After all the problem with pensions is when they are hit it’s really to late to do anything about them. The money is trapped and, like children in schools, easy pickings for predators.

  3. “Can’t see it happening though, as long as MPs are in the higher tax band.”

    What? MPs have defined benefits pensions. They will get a fixed proportion of final salary, and pay prevailing tax rates at that time, assuming they reside in the UK.

    This new tax burden will only affect people who are building up a pension pot and whose pension benefits depends on the size of it.

    Senior civil servants, miltary officers, judges etc will be untouched. No idea what the guiding principle behind excluding these people from new taxes on pension savings is…

    With current annuity rates, an index linked joint life pension of “only” 30K drawn from 55 would cost an ordinary mortal £1M. Based on this does anyone know how many “pension millionaires” the public sector empoys?

  4. What? MPs have defined benefits pensions. They will get a fixed proportion of final salary, and pay prevailing tax rates at that time, assuming they reside in the UK.

    Yes, but they can choose to top up just like anyone else since their pension is determined by length of service. I know it looks as though they all have a job, doing nothing, for life but some get voted out. They still benefit from reliefs at the higher rate.

    As for your pensions millionaires, any copper of senior-ish rank – Chief Inspector sort of level – with the full 30 years might reasonably expect £100,000 cash plus £30,000. At 50. That’s before examining any snouts in troughs elsewhere. Pun not intended but it’ll do.

  5. Hmm, where do you get that 80% from? I don’t quite follow you there. To me, if the pension is taxed 20% at contribution time and 50% (marginal) when it’s taken out, the total rate is 100% – (50% of 80%) = 60%. Or does the tax scheme not work that way in the UK?

  6. “The effect is worsened because a higher-rate taxpayer who has some spare cash (whether from earned income or not) can dump it in to a pension plan and still get the income tax relief.”

    This is a very small effect as pension contribs are a limited proportion of income and this particular issue only affects those who are
    a) just on the edge AND
    b) can afford to make payments that take them below that band.

    Even so, the cash payment is not a problem either. That cash would have been taxed as income in the year that it was earned. You pay it into your pension, you get the tax relief.

    It’s absurd because clearly, standard rate taxpayers on lower incomes subsidise those on higher incomes.

    No it’s bloody not. It’s the rapacious Government giving you back your own money.
    And in the very very small number of marginal cases, it still isn’t.

    I’m sure Tim can find us the precise figures, some staggering proportion – 50% from memory – of income tax is raised from the top 10% of earners.

    So no, std rate payers aren’t subsidising anyone.

    Remember: every time someone mutters about some bankers £10M bonus, think to yourself, that’s a £4.1M bonus -utterly and completely unearned – for the taxman.

  7. Oh sorry – your £10M bonus is now split as follows:
    Taxman: £5.1M, banker £4.9M.

    I’m not weeping for the banker, but don;t forget that the taxman does quite nicely thank you too.

  8. “people paying higher rate income tax on the top slice of their earnings get pension contributions tax relief at 40% even if they only just make it into the higher rate band.”

    That’s not how HMRC did it on my last tax return: they did the calculation by lifting the higher rate threshold by the amount of the pension contribution.

  9. The pensions industry is undoubtedly in need of a shake up, but has been so for donkeys years. It seems to have gone unacknowledged by the politicos that the big pension contributors have subsidised the admin cost of the crappy little CAT type schemes which get offered up to the plebs. If the decent business takes flight from the pension industry, the providers might feel rightly justified in telling the government to take back the tens of thousands of unprofitable, low value schemes which the providers have agreed to take on in past years. This would cost the state far more than any savings in tax relief for the higher rate taxpayers.

    Given that UK exempt approved schemes come with many restrictions and tend to be managed by the numpties within the investment field, the rate of relief going into such schemes is often critical factor to many in weighing up whether contributing is worthwhile. My guess is that the inclination will now be to look elsewhere to alternative, less restrictive and better performing, investment opportunities. If so, logically, the capital will take flight to the hedge funds and similar, and leave the UK as a consequence.

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