Are Pension Tax Breaks Really Worthwhile?

Are Pension Tax Breaks Really Worthwhile?The great pension tax relief debate is taking place in smoke-filled rooms and in whispers in corridors away from the attention of ordinary retirement savers.

The government is eyeing a saving of £35 billion a year on pension contribution relief, claiming the tax break is aimed at encouraging retirement savers but has little real evidence to support the widely-held view.

The argument is basic rate taxpayers gain little from the incentive because although they have their pension contributions increased by 20% while saving, but the same money is taxed at 20% when paid out as a pension.

This is mainly because the state pension takes up the majority of the personal income tax allowance for a retiree, pushing pension benefits into a taxable zone.

Tax neutral pensions

So, the reality for many basic rate taxpayers is their pensions are tax neutral and the only tangible tax break is not paying any tax on fund growth or any dividend or interest payments earned from pension investments.

ISAs offer the same tax advantages on growth. Money out is tax-free but does not attract any tax relief going in.

Many advisers also argue that only the wealthiest pension savers put aside more than the maximum limit on an ISA, which is £11,250 for the 2013-14 tax year, allowing a couple to invest £22,500.

Higher rate taxpayers gain more because they get double the relief going in (40% or 45%) and only half the tax on their pension benefits (20%) because the payment leaves them in the basic rate tax bracket even when the state pension is added in.

So, says the Treasury, pension contribution relief does little to incentivise lower paid workers to save for retirement, especially with the advent of automatic enrolment.

Debate is overdue

That leaves a tax break for wealthier workers subsidised by taxpayers generally earning less.

The question is whether those billions spent every year are worthwhile or would they be better spent on reducing the budget deficit while leaving wealthier taxpayers to pay their own way through retirement without a subsidy from the rest.

A Treasury spokesman said: “Tax relief on pension contributions is aimed at encouraging and supporting saving for retirement and that is why such generous tax relief is offered on contributions and investment growth.

“Nevertheless, the cost of that tax relief is rising, and we feel a legitimate public debate about retirement saving and how the government can best help those that want to invest is overdue.”

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