Higher earners will need to pay more into their pensions

A break from the long-standing principle that an individual receives tax relief on their pension contributions at their highest marginal rate

The chancellor announced during the Budget that from April 2011 the highest level of tax relief will be restricted for those earning more than £150,000 a year, and it will disappear altogether for those with income over £180,000.

These higher earners will only receive basic rate relief on all pension contributions, which according to the government will help create a “fair and modern” pension system. In 2007/08 the government allocated almost £30bn for tax relief on pensions last year.

The loss of this higher-rate relief will mean that higher earners are now going to need to pay more into their pensions if they want to keep the same pension contributions levels as before. For example, an employee earning £200,000 a year putting 6pc of their salary into a pension scheme, equates to a contribution of £12,000 a year, and currently would cost £7,200 after higher rate tax relief.

On this salary this person would only receive basic rate tax relief after 2011, so the same contribution would now cost them £9,600 a year, or an extra £200 a month. If they do not want to pay this additional sum, then over a 25-year period this loss of extra tax relief would mean their pension pot is worth £174,469 less. This would give them £974 less a month in retirement.

While this change appears to only impact on the very high earners, it breaks the long-standing principle that an individual receives tax relief on their pension contributions at their highest marginal rate.

Although these changes will not come into effect for two years, the government is introducing emergency legislation into this year’s Finance Bill to stop high earners making large contributions to their pension plans now to gain advantage of this higher tax relief.