Page last updated at 15:18 GMT, Monday, 1 March 2010

Pensions tax changes for high earners criticised

Reading a tax return
The government's plans face growing criticism

The government's plans to tax the pension contributions of high earners have been criticised as "complex, unfair and inefficient".

The Institute for Fiscal Studies (IFS) also says many wealthy people will simply alter their pay arrangements to avoid the new taxes.

From April 2011, the government hopes to raise an extra £3.6bn a year from about 300,000 top earners.

That is on top of a new 50% tax rate and the withdrawal of tax allowances.

Those two measures, starting next month, will raise about £3.9bn by phasing out the universal personal income tax allowance from anyone earning over £100,000, and by taxing people at 50% on their earnings over £150,000.

The pension tax changes, which will come in a year later, will steadily reduce the tax relief high earners can obtain on their own pension contributions, once they earn over £150,000.

And some high earners will be taxed on the value of the pension contributions made by their employers.

This could affect people with gross pay of just £130,000 if the benefit of their employers contributions pushes them above a proposed £150,000 limit.

"The average tax increase would be a whopping £12,000 per affected person per year," said Carl Emmerson, deputy director of the IFS.

Salary sacrifice

The government wants to restrict the amount of pension tax relief given to high earners.

Higher rate tax payers were given 65% of the £28bn granted in pension tax relief in 2008-09, though they make up just 19% of pension savers.

And the very highest earners, the 1% of adults whose income is over £150,000 a year, gained 25% of all pension tax relief, worth an average of £20,000 a year to each of them.

The IFS argues that it would be possible for many of them to alter their pay arrangements by using a concept known as "salary sacrifice", in which they take smaller salaries in exchange for larger pension contributions.

By doing this some could depress their earnings below the £130,000 starting point for the new pension tax restrictions.

"Treasury figures suggest that nearly two-thirds (63%) of the 300,000 individuals potentially affected by this reform are members of defined contribution schemes, which are inherently more flexible [than final-salary scheme]," said Mr Emmerson.

"The scope for some individuals to respond to this reform in a way that minimises its impact on their lifetime tax bill must mean that estimates of the Exchequer gain from the reform are subject to a large degree of uncertainty."

Tax-free cash

The IFS suggested that one alternative to the government's plans would be to restrict the amount of tax-free cash people can take from their pension pot when they retire.

"The most obvious anomaly is the fact that individuals can take up to 25% of their pension as a lump sum free of income tax up to a maximum of £437,500," it said.

"A reform that placed a much smaller cap on the amount that can be taken as a lump-sum would improve value for money for the public purse as there is no obvious justification for providing such a generous amount tax free," it added.

The government is currently consulting on its pension tax proposals before finalising details of any changes.

Last week, the National Association of Pension Funds said the proposals would do "enormous harm" to company pension provision and called on the government to abandon its plans.

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