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UK gov't warned against cutting pension tax relief

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UK - Pensions industry experts have the UK government not to abolish higher rate tax relief on pension contributions as such a move would not be straightforward to introduce and could undermine confidence in pensions, leading to a general levelling-down of provision.

Rumours suggesting that the government is planning to reduce the level of tax relief on pension contributions for higher earners from 40% to 20% in the UK Budget, delivered by chancellor Alistair Darling (pictured) this Wednesday has been met with concern by the industry.

The National Association of Pension Funds (NAPF) warned the move would be "highly damaging at a time when government policy is rightly directed at increasing pension saving. Such a move would have a negative effect on employees and also employers operating defined benefit (DB) schemes".

It argued that removing the higher rate tax relief would "undermine consumer confidence in pensions, reduce the value of pensions and penalise those who taking responsibility for their retirement", while it would also prompt employers to review contribution rates and benefit levels with the likely consequence of prompting "a further wave of closures and a general levelling down of provision".

Watson Wyatt suggested it would be "easier said than done" if the government is looking at this measure as a way of improving public finances, because of the extent of DB members still accruing benefits, and because it could mean people saving in a pension would be taxed more than those not saving.

John Ball, head of DB pension consulting at Watson Wyatt, said: "The Pensions Commission found this idea tempting but could not find a way to do it while DB pensions remained part of the landscape. This is because it will be decades before we know for sure how much the pensions being earned today are worth and therefore how much tax should be paid by the people earning them."

He also warned if people have to pay tax while saving for a pension and when they receive payouts "those who expect to be higher rate taxpayers in retirement could be better off saving in other ways", and may be driven to accept lower salaries - to pay less tax at 40% - in return for employers making contributions for them, as these contributions are not taxed as a "benefit in kind".

The end result might be that the Exchequer could instead end up losing money because employer contributions are not subject to National Insurance Contributions (NICs).

Elsewhere, Tom McPhail, head of pensions research at Hargreaves Lansdown, said cutting the tax relief would only be worth around £2.3bn (€2.6bn) a year to the government, compared with the annual state expenditure on pensions of £115bn.

McPhail revealed of the £115bn spent in 2007/08, only £29.5bn was spent on tax relief and only £7.9bn of that was on employee contributions, as the majority went to employers and the remainder was split between state pensions, worth £70bn, and public sector pensions worth £15.5bn.

"UK pension provision is in a fragile state; withdrawing higher rate tax relief would be reckless, unfair and arguably unworkable," said McPhail. "If the government chooses to go down this road it will leave a legacy as the administration that demolished incentives for people to save for their own retirement."

Stephen Haddrill, director general of the Association of British Insurers (ABI), said the organisation is "seeking urgent reassurance" on the speculation as it would be "an entirely wrong and short-sighted response to the huge challenges facing the government. Half of the UK's workforce are not saving enough for a comfortable retirement already. We need more people to save, not to punish those who are already doing so."

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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