Moves to limit tax relief on the pension contributions made by middle and high income workers threatens to wipe tens of thousands of pounds off the value of retirement nest eggs, it is claimed.
Chancellor Rachel Reeves is rumoured to be looking at removing or scaling back the higher rates of tax relief that is available on pension contributions made by people who are paid over £50,270 a year.
As a result, this group of workers would end up with a much smaller pension pot when they reach retirement unless they divert much more of their salaries into workplace schemes during their careers.
Currently, a basic rate taxpayer gets 20 per cent tax relief on pension contributions, which means every £100 they put into a scheme costs them £80.
However, someone earning between £50,271 to £125,140 and paying 40 per cent tax gets more generous tax relief on pension contributions at this same rate. This means every £100 put into a pension scheme costs them £60.
Currently, a basic rate taxpayer gets 20 percent tax relief on pension contributions (Image: Getty)
And people paid over £125,140 get tax relief at 45 percent on pension contributions, which means paying £100 into a scheme costs them £55.
The Chancellor is understood to be looking at equalising the tax relief on pension contributions at 30 percent for all workers or even 20 percent.
It is estimated that capping upfront income tax relief for pension contributions at 20 percent would raise £15 billion for the Government, while a flat rate of 30 percent rate would generate £2.7bn.
Experts at wealth management firm Quilter show that moving to a 30 percent rate of tax relief would see the final pension pot of a high earner shrink by more than 10 percent, bringing it down from £794,984 to £711,477.
By contrast, introducing a 30 percent flat rate would be good news for most workers who currently pay 20 percent tax. Thiis group would see their pension pot on retirement rise from £288,090 to £315,897.
The analysis assumes a basic-rate taxpayer starts saving into their pension aged 25 on a salary of £22,320 a year and the higher-rate taxpayer starts on £50,270.
They both work for 41 years until they retire at the age of 66, with annual wage growth of 2 percent, pension contributions of 3 percent from them and 5 percent from the employer, and 4 percent pension pot growth per year net of fees.
Ian Cook, of Quilter Cheviot, said that transitioning to a flat rate system would be a “complex undertaking” that would “fundamentally alter” how tax relief is applied.
He added: “To make flat rate relief work, all pension contributions, including employer ones, would need to be standardised. This could require substantial changes to the current system where contributions are deducted pre-tax.
“Given the complexity of such changes, a considerable period of consultation and phased implementation would be likely, possibly over years rather than weeks or months.”
A Treasury spokesman said: “We do not comment on speculation around tax changes outside of fiscal events.”