I wrote this week about talks between the Tories and Lib Dems about the possibility of lowering the cap for how much workers can put into their pension pots while still enjoying tax relief.
Since then a couple of pensions experts have got in touch to explain some further implications of the measure, which mean that for two reasons, it could be more controversial than I first realised.
Firstly, I suggested that people enjoying the maximum 50% tax break enjoy a 50p top-up to their pension pot for every £1 they put in.
In fact, the relief is worth even more, because the amount is a tax relief calculated on pre-tax income. So if you qualify for the 50% relief, and put in £1, your tax is waived, meaning that the government has essentially put in 50p of the £1 you put it. Cancelling this for some people would therefore be even more of a blow than I first calculated.
Secondly, and more importantly, while I suggested it is likely to be bankers and other high-earning City types who are most affected, this is not necessarily the case: because of the complicated maths of pension contributions, it could end up being public sector managers who take the hit.
The reason for that is this:
1) Any seriously well-off banker will have already hit the lifetime limit for tax-free pension contributions, so any move to remove relief from them won’t have an effect.
2) While it is true that to qualify for the annual cap, you have to earn £1m, that is only true for defined contribution schemes. For defined benefit schemes (such as a final salary scheme), contributions are calculated differently. John Ralfe, the pensions experts, has the actual maths:
The annual allowance for defined benefit pensions is calculated as the annual accrual, plus the increase in prior years, minus inflation, multiplied by 16.
So if you are in a career average scheme with a 1/60th accrual and earn £60k, then the pension benefit is £16k, ie £60k/60 x 16.
The logic of the maths is not as important as its consequences. What it means is that those on defined benefit schemes hit the cap much sooner than those on defined contribution. And who has defined benefit pensions? Already beleaguered civil servants. Suddenly the politics of this looks a little more complicated.
So who would be hit? Even under defined contribution schems, you would still have to earn a lot to hit the cap. According to Ralfe’s calculations:
If we take the terms proposed for the civil service of an accrual of 1/44th then someone earning £75,000 would have a deemed benefit for tax of £27,000. Someone earning £100,000 would have a deemed benefit of £36,000.
Even if the cap is brought down from £50,000 to £40,000 therefore (this is just a supposition), civil servants earning £100,000 would still not hit it. As one former Treasury wonk said to me: “This would only really hit the top brass.”
Although it isn’t quite the bankers’ pension tax that I first thought, it should still be a relatively simple sell to tax these people more – especially given the coalition rhetoric about “gold plated public sector pensions”.
I spoke to a former Treasury official who used to promote this policy when in government and the person said: “I never felt this was anything I couldn’t sell politically.”