AJ Bell press comment – 23 September 2022
- Chancellor Kwasi Kwarteng this morning announced dramatic changes to income tax rates in the UK
- The basic rate of income tax will be cut from 20% to 19% in 2023, while the additional rate of income tax will be scrapped altogether
- Both moves will have implications for pension tax relief:
- The effective pension saving ‘bonus’ for a basic-rate taxpayer will fall from 25% to around 23%
- The saving bonus for additional-rate taxpayers will fall from around 82% to 66% (see end of press release for worked examples)
- Pension schemes administering on a ‘relief at source’ basis will have until April 2024 to shift to paying 19% tax relief to basic-rate taxpayers
Tom Selby, head of retirement policy at AJ Bell, comments:
“Chancellor Kwasi Kwarteng’s decision to lower the income tax rates paid by basic and additional-rate taxpayers is clearly intended first-and-foremost to allow people to keep more of their pay and help spur the economy into life. However, both will also have a knock-on impact on retirement saving incentives when people pay into a pension.
“Because pension tax relief is paid at your marginal rate of income tax, lowering the tax people pay also reduces the amount of tax relief they are entitled to.
“For basic-rate taxpayers, lowering income tax from 20% to 19% will cut the effective pension saving ‘bonus’ provided by tax relief from 25% to around 23%. For additional-rate taxpayers, reducing the income tax rate from 45% to 40% will see their savings bonus drop from around 82% to 66%.
“Pensions of course remain extremely tax-efficient long-term savings products for people of all income levels. For basic-rate taxpayers saving outside of automatic enrolment, the reduction in tax relief to 19% will however mean that Lifetime ISAs, which continue to offer a savings bonus equivalent to 20% tax relief, will become comparatively more attractive.
“One other important thing to note is the transitional period afforded certain types of pension scheme. For basic-rate taxpayers saving in ‘relief at source’ schemes – where basic-rate tax relief tax relief is added automatically - there will be an extra year during which they can continue to receive tax relief at 20%. Those in ‘net pay’ schemes, meanwhile – where contributions come straight from pre-tax pay – will presumably receive 19% tax relief from April 2023 onwards.”
How the current system works*
- Basic-rate taxpayer – pays in £80, gets £100 in their pension (20% tax relief, 25% bonus)
- Higher-rate taxpayer – pays in £80, gets £100 in their pension, claims back £20 (40% relief, 66% bonus)
- Additional-rate taxpayer – pays in £80, gets £100 in their pension, claims back £25 (45% relief, 82% bonus)
Under new tax rates – once fully implemented*
- Basic-rate taxpayer – pays in £81, gets £100 in their pension (19% tax relief, 23% bonus)
- Higher-rate taxpayer – pays in £81, gets £100 in their pension, claims back £21 (40% relief, 66% bonus)
- Additional-rate taxpayer – pays in £81, gets £100 in their pension, claims back £21 (40% relief, 66% bonus)
*Assumes member is in a relief at source scheme. Members in net pay schemes will have the full amount of tax relief paid automatically unless they are a very low earner.
