Pension tax changes will encourage saving, says minister

By Brian Milligan
Personal Finance reporter

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Forthcoming changes to the way pensions are taxed will "encourage saving", a government minister has told the BBC.

David Gauke, the Financial Secretary to the Treasury, said a review of pension taxation would keep savers in mind.

"We need to ensure it is effective in terms of encouraging saving, and it is going in the right place," he said.

The Chancellor, George Osborne, is due to announce the result of a Treasury inquiry into pension taxation in the Budget on 16 March.

Mr Gauke's comments, made on BBC2's Daily Politics Show, are likely to be seen as encouraging for those who believe that pensions should continue to be taxed when money is taken out of them, rather than before it is put in.

One idea considered by the Treasury was to make pension saving more like contributions to Individual Savings Accounts (Isas), which are taxed on the way in, but subsequently grow tax-free.

The existing system is thought to encourage saving more effectively, as consumers receive immediate tax relief on contributions.

'Punishing' high earners

The other change being considered by ministers is to replace variable tax relief on pension contributions with a single, flat-rate.

At the moment, basic rate taxpayers receive 20% tax relief, higher rate taxpayers receive 40%, and those with the highest incomes receive 45%.

It is thought that this system could be replaced with a flat rate of anything between 25% and 33%.

Millions of high earners would lose out in such a system, but basic rate taxpayers would stand to gain.

"Nobody wants to punish anybody," said David Gauke.

"But it is, of course, right that we look - in a careful and consultative way - at the way pension tax relief works."

How would a flat rate work?

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How much savers stand to win or lose under a flat-rate system depends very much on the rate chosen.

A higher rate taxpayer making a £10,000 pension contribution currently gets tax relief of £4,000.

Under a new flat rate of 25%, they would only receive £2,500, a loss of £1,500.

However a basic rate taxpayer would gain £500. The higher the rate chosen, the more savers would gain, but the more it would cost the Treasury.

Some experts believe any change will come into immediate effect on Budget day, to prevent higher earners making emergency contributions - a scenario that could cost the Treasury £6bn.

"Any higher earners who are looking at paying into a pension, should think seriously about doing so before 16 March," said Tom McPhail, pensions expert at Hargreaves Lansdowne.

"Conversely, for basic rate taxpayers, it may make sense to wait until after that date."