The government could bring down the shutters on the current tax relief system immediately on 16th March 2016 to avoid tax leakage that could rise into billions of pounds warns Hargreaves Lansdown.
Reflecting on media reports that higher rate tax relief is to be abolished and possibly replaced with a flat rate relief of either 20, 25, 30 or 33 per cent, Hargreaves Lansdown head of pensions policy Tom McPhail also warned the new system would probably spell the end of salary sacrifice in its current form.
McPhail says such a move would need rapid action to stop the 2016/17 year becoming a last hurrah for contributions that would cost the Treasury around £6 billion pounds within just a few months.
McPhail says the risk of 5 million higher rate taxpayers making large contributions in a last year of higher rate relief would be so unpalatable to the Treasury that it is likely to bring in new rates immediately.
He says salary sacrifice would need to be either abolished or restricted to the employer minimum for auto-enrolment to avoid the Treasury losing out by employees opting to be paid exclusively through employer contributions rather than employee contributions. Alternatively, tax charges would need to be levied on the employer pension contributions made on behalf of higher rate taxpayers. If a 33 per cent flat rate were adopted then an extra levy of 11.5 per cent would be needed to maintain tax neutrality.
McPhail says: “If each of the 5 million higher rate taxpayers made a £10,000 contribution we are talking many billions of pounds of lost tax relief. If that happens then they would probably bring down the shutters on 16th March.
“They would also need to deal with salary sacrifice as a matter of urgency.
“Superficially, flat-rate makes sense. The consequences of it will be felt by high earners, but also by employers and pension scheme administrators. Reform of pensions taxation and National Insurance was always going to be needed after pension freedoms.
“Some schemes are set up on the basis of pension contributions being deducted from employees’ gross pay (confusingly, this is known as ‘Net Pay’). It would take time to shift such schemes across to a flat rate pension system. The government could announce that existing regular contributions through Net Pay can continue until April 2017, thereby giving employers and the industry time to adapt. Various parties involved in pensions (including the Pensions Minister) have become increasingly concerned about the fact that the Net Pay system can result in lower earners missing out on tax relief.
“A move to a flat rate incentive system would almost certainly be accompanied by a wholesale shift across to the other method of tax relief, known as ‘relief at source (RAS)’ whereby an investor makes a contribution net of the tax relief and the pension provider then claims a top up from the government. For example, under the current system, whereby tax relief is granted at 20 per cent under the RAS system, a payment into a pension of £80 gets topped up to £100. If the top up rate were increased to 25 per cent, then an investor would only have to pay in £75 to get it topped up to £100 by the government.”