The taxing cost of pensions

HMRC has updated its estimates for the cost of pension tax relief. Rachel Reeves will have taken note ahead of her first Budget on 30 October.

Source: HMRC

It was pure coincidence, but two days after the Chancellor had revealed a £22 billion black hole in government finances for the current financial year, HMRC released its annual update of the cost of pension tax reliefs. The headline figure (for 2022/23) was £48.7bn, more than twice the size of that black hole.

That huge multi-billion figure of pension relief is not as straightforward as it seems, a point often missed in media coverage. It is the sum of seven separate components:

Source in 2022/23	£ billion
Personal income tax relief on contributions made by employers, employees and the self-employed.	42.5
National insurance contribution (NIC) relief on employer contributions.	15.4
NIC relief on employee contributions.	8.5
Personal income tax relief on pension fund investment income.	4.3
less
Personal income tax on payments from pension schemes.	(21.1)
Annual allowance charges	(0.3)
Lifetime allowances charges	(0.5)
TOTAL*	48.7

*Figures do not total due to rounding

The standout element is the £42.5 billion of income tax relief on pension contributions, nearly two-thirds of which is claimed by higher and additional rate taxpayers (as shown in the ‘Pensions Contributions: Income Tax Relief’ pie chart above). The current freeze on personal allowance and higher rate thresholds, along with the near £25,000 reduction in the additional rate threshold in 2023/24, has likely exacerbated the skew.

In the words of many pre-Budget commentaries, pension contribution tax relief is a ‘low-hanging fruit’ for any chancellor looking for extra revenue. However, to date, the pickings have been limited to reducing the maximum tax-relievable contribution via the annual allowance rather than the rate of relief. This salami-slicing approach has created its own problems, notably among NHS consultants and senior doctors who were encouraged to choose early retirement or reduced hours rather than paying pension tax charges.

The possibility of cutting the rate of income tax relief is now being reconsidered by the Treasury, according to several media reports. For example, replacing the current system with a single 30% flat rate of relief would benefit most taxpayers (who currently receive 20% basic rate relief), but save the Exchequer about £3 billion a year. If you are not a basic rate taxpayer, you may want to bring forward any planned pension contributions before 30 October, when Rachel Reeves presents her first Budget.

Articles on this website are offered only for general informational and educational purposes. They are not offered as and do not constitute financial advice. You should not act or rely on any information contained in this website without first seeking advice from a professional. Past performance is not a guide to future performance and may not be repeated. Capital is at risk; investments and the income from them can fall as well as rise.