Lisa Webster: Back to basics with pension tax relief

Over the last few months, we’ve seen several announcements of big changes to income tax. Back in March we were told basic rate tax was going down to 19% – but not until April 2024. Then in September, in the now infamous Kwarteng mini-Budget, we were told not only was that being brought forward to April 2023, but that the additional rate tax was going to be scrapped altogether. We all know how well that plan went down, with the additional rate tax cut being quickly abandoned. The bringing forward of the basic rate cut presented some interesting scenarios, as it was proposed we would have a year of paying basic rate tax at 19%, while still getting tax relief at 20% on personal contributions to relief at source pensions. In the time when the changes were on the table, I did some figures on the impact for tax relief, looking at things like maximising carry forward this year for additional rate taxpayers before the proposed cut, as well as looking at how much could be gained when the basic rate tax paid was different to the relief given. For comparison, I explored the scenarios for Scotland if their rates remained unchanged compared to the rest of the UK. Needless to say, all of this is now out of the window and we are back to where we started. However, it has made me think about tax relief again, and going back to basics three things stuck out. First, the underlying concept of tax relief on personal pension contributions is that you get back the tax you have paid. So, whatever the rate of tax is, it will cost you the same amount to get your contribution into your pension. The only exception to this is if you make contributions relating to income you do not pay tax on – that is within your personal allowance. And you need to have available annual allowance to avoid a tax charge. The key point here is that pension contributions make sense for tax relief purposes whatever the rate when full relief is given. Second, salary sacrifice is always better than personal contributions (from a tax point of view). It is not just income tax changes that have been bandied about, we’ve also had different rates and thresholds for national insurance (NI) throughout this tax year. However, if you use salary sacrifice NI can be saved, whatever rate it is at. Third, net pay schemes are still an issue. They work well for higher earners, with full tax relief being granted automatically, but low earners miss out. Had relief at source remained at 20% for a year when basic rate tax was paid at 19%, there would have been many more losers too. Although there is a ‘remedy’ planned – the first claims cannot be made until 2025/26 relating to the 2024/25 tax year. It also looks like lower-paid employees will have to take action to claim the extra tax relief, unlike it happening automatically under relief at source schemes. This of course means there are likely to be many that do not bother, especially when you consider these are likely to be some of the least engaged pension savers. Lisa Webster is senior technical consultant at AJ Bell. She is an economics graduate with over 15 years’ experience in financial services. Prior to joining AJ Bell in May 2014 she spent nine years working in senior technical and consultancy roles at a major SIPP and SSAS provider. She is part of the AJ Bell Technical Team, responsible for providing regulatory and technical analysis to the business and outside world. Email: This email address is being protected from spambots. You need JavaScript enabled to view it. Twitter: @lisasippster

Lisa Webster: Back to basics with pension tax relief

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