By starting from a young age, saving regularly and taking advantage of the benefits of tax relief, UK savers could reap huge financial rewards and give their retirement savings a huge boost, but following suggestions that tax relief reforms could be on the horizon, a leading pensions expert has urged Britons to make the most of this ‘attractive’ offering while they still can.
New analysis has highlighted that pension tax relief is worth tens of thousands of pounds to regular savers over the course of their working lives. However, the savings incentive that turned 100 this year faces possible reform from the government as it seeks to balance the books, and any change could create significant winners and losers.
Aegon’s analysis found that an individual who starts contributing £100 per month to their pension from take home pay from age 22, and who increases that with earnings growth of three percent, could have a pension pot of £354,600 at a state pension age of 68.
Of this, £70,900 or 20 percent of the total is down to the tax relief ‘top-up’ they receive from the Government. These figures take account of personal contributions and do not include any employer contribution the individual might also receive.
Currently, basic rate taxpayers get tax relief at 20 percent on their personal contributions which means contributing four percent from their take-home pay is increased to five percent.
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For a higher rate taxpayer, the benefits of pension tax relief are even more significant. Currently, higher rate taxpayers receive tax relief at 40 percent on their personal contributions. Someone who starting saving £300 from take home pay from age 30 could have a pension pot of £877,900 at age 68. Of this, £351,100 or 40 percent is from the higher rate tax relief they currently receive.
Pension tax relief was introduced as part of the Finance Act of 1921, but despite its 100-year pedigree it remains one of the least understood savings incentives. However, the incentive looks set to be the focus of intense debate both in government and among the public, if as has been suggested, it is to be reformed.
With the Budget just around the corner at the end of October, there has been speculation that the Chancellor Rishi Sunak may seek to reduce the generosity of tax relief to higher rate taxpayers and introduce a flat rate of tax relief, somewhere between 20 percent and 30 percent.
If this was the case, while higher rate taxpayers would lose out, this would benefit those who pay basic rate tax.
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Aegon’s analysis highlighted just how significant this could be for higher rate taxpayers. For the higher rate taxpayer example above, moving to a flat rate of 30 percent from the current 40 percent means an individual’s fund would fall from £877,900 to £752,400 at state pension age, a reduction of £125,400.
To maintain their projected fund, they would need to increase their starting contribution from take home pay by £50, from £300 to £350.
Steven Cameron, Pensions Director at Aegon commented on the analysis and emphasised the benefits of tax relief as a means of topping up one’s pension savings.
He said: “Pensions are a very attractive way to save over the long-term in part due to the top up the government provides through tax relief. For a basic rate taxpayer, a £100 pound contribution from take home pay is currently boosted to £125 after tax relief and a £300 per month contribution from take home pay for a higher rate taxpayer is boosted to £500.
“Over the years the value of the tax relief element of pensions contributions is worth tens of thousands of pounds, even to those on modest incomes.”
Mr Cameron also gave his thoughts on the potential implications of the Government changing the parameters of tax relief and how it could impact people’s ability to save for their long-term future.
He said: “If pension tax relief is reformed it will represent a major change to the current system after 100 years and there will be significant winners and losers if, as has been trailed, a flat rate is introduced somewhere between 20 percent and 30 percent.
“For higher rate taxpayers this would mean having to make additional pension contributions to offset the reduction, while basic rate taxpayers would experience an uplift to their pensions.
“For a basic taxpayer, an increase in pensions tax relief from 20 percent to 30 percent will mean their monthly pension contribution of £100 from take home pay is boosted by £18 a month.
“Over the course of a working life, this could mean an individual builds an additional £50,600 into their pension fund. This assumes contributions rise annually by three percent and investments grow at 4.25 percent.”
With the full state pension at £179.60 per week or £9,339.20 a year and the full basic state pension at £137.60 and £7,155.20 for the year, it is likely that the state pension alone will not be enough to sustain Britons once they enter retirement.
This brings the importance of personal retirement saving into focus, with the responsibility falling on savers to ensure they have enough money in their pension pots.
Tax relief is a potentially useful tool which could help future retirees rack up a healthy amount of savings.