David Prosser: Less cream for fat cats of pensions

Outlook Listen carefully as you pass through some of the more well-heeled areas of our fair isle and you may just be able to hear the howls of protest. Many of Britain's highest earners – not to mention the pension professionals who advise them – are up in arms about new restrictions on the tax relief they get as they save for retirement. The restrictions were first announced in the pre-Budget report at the end of last year, but a Treasury consultation paper on how they would be implemented has been doing the rounds during the past day or two, much to the consternation of those affected.

For many years, savers have enjoyed tax relief on pension contributions at their highest marginal rate of tax – 40 per cent currently in the case of higher-rate taxpayers. The Treasury was concerned about a big increase in the cost of that relief when the 50 per cent top rate comes into force next month, so the Chancellor has made a pre-emptive strike. Henceforth, those earning more than £130,000 a year will see the relief they get on pension relief restricted – it tapers down to just 20 per cent for those earning £180,000 or more.

The howls of protest come from two camps. One criticism is that the new rules will be complicated and that there will almost certainly be anomalies, with certain savers hit harder than others. More fundamental is the complaint that it is unfair to single out high earners in this way: higher-rate taxpayers may get much more generous pension tax relief than others, but they are also likely to be paying higher-rate tax on their retirement income, so they don't necessarily finish up any better off.

Both arguments have their merit. But in truth, the complexity of our pension system means it is almost impossible to change the system without creating anomalies. And though the wealthiest savers may indeed be penalised unfairly by these reforms, the cost of pensions tax relief is unsustainable in the current fiscal environment.

The Treasury reckons its reforms will raise £3.6bn a year, which gives you an idea of just how vast the budget for higher-rate pensions tax relief has become. Indeed, the TUC estimates that of the £37bn total annual cost of pensions tax breaks, the richest 1 per cent of the population grabs £10bn.

The Institute for Fiscal Studies, for one, thinks the proposed reforms are the wrong way to tackle this problem. It would rather see, for instance, a lowering of the maximum sum that savers may take as a tax-free cash lump sum from their funds on retirements – currently 25 per cent of savings, up to a maximum of £437,500.

That's not a bad idea, but it could be done in addition to cut-backs on tax relief. To those who say that it is a bad idea to withdraw incentives for saving for old age, the answer must be that with fiscal restraints as they are, it is time to cut our cloth accordingly. It's difficult to imagine that any of the people in this bracket might become a burden on the welfare state should they begin receiving less tax relief. No, they would simply be a little less well-off in retirement.

Stability is important in pensions policy. Broadly speaking, people need to know that when they put money by for 20, 30 or 40 years' time, the rules will not change during the intervening period in such a way that they are penalised for having been prudent. This is not to say, however, that all pension rules and regulations are set in stone – there will always be circumstances in which changes must be made. And under the current proposals, even the wealthiest earners will go on receiving very generous tax reliefs. The richest section of the population will continue to receive a disproportionate share of the pot of money put aside for this purpose – just a slightly less disproportionate share than now.

Indeed, those who are howling their disapproval just now need to be careful about drawing too much attention to themselves. There is a case for going much further in cutting back pension tax reliefs than the proposals envisage. And as the need to raise cash for the Treasury's coffers becomes ever more pressing, they are an easy target.