The Government is to slash high earners' tax-free pension allowances from £250,000 to just £50,000 a year, raising an extra £4bn for the Exchequer.
The new cap – which is higher than the £30,000 to £45,000 level originally proposed – will affect about 100,000 people, 80 per cent of whom are earning more than £100,000 per annum, according to the Treasury.
The changes will come into effect in April and individuals exceeding £50,000 due to a one-off "spike" will be able to offset it against unused allowances from previous years.
Alongside the reduced annual cap, the tax-free allowance for lifetime pension contributions will also be reduced from £1.8m to £1.5m from April 2012.
The moves come barely more than a week after the decision to scrap child benefit payments to higher income families, as the Coalition Government looks for political cover for savage public sector spending cuts to be unveiled next week.
Yesterday's announcement from the Treasury also follows the publication of Sir Philip Green's public sector waste review and Lord Browne's recommendation of an increase in university tuition fees earlier this week.
Mark Hoban, the Financial Secretary to the Treasury, yesterday stressed the fairness of the new tax rules for pension payments. "The Coalition Government believes that our system is fair, will preserve incentives to save and – compared to the last Government's approach – will help UK businesses to attract and retain talent," Mr Hoban said.
But accountants warned that the number of pensions savers affected by the changes could be as many 200,000, double the Government's estimates, if allowances remain frozen and inflation pushes up salaries.
And although the limits are higher than feared, the tax implications for people in final-salary schemes seeing large pay rises is still significant. An executive on a salary of £150,000 with 20 years' service in a final salary scheme will face a tax bill of £12,200 on a pay rise of £9,000, a combined tax rate of 185 per cent, Marc Hommel, a pensions partner at PricewaterhouseCoopers, warned.
"Some affected employees may decide it is worth breaching the allowances and stomaching the extra tax to ensure no loss to their future retirement income," he said. "However, this will be unaffordable for many people."
Business groups welcomed the new rules yesterday. John Cridland, the deputy director-general at the CBI, said the changes were "not as bad as feared" and a "significant improvement" on the previous government's "unworkable" scheme.
The pensions industry also endorsed the changes, after months of campaigning against Labour's plans to taper tax relief to zero as income increased above £150,000.
Maggie Craig, the director general of the Association of British Insurers, said: "This is a much-more practical way to incentivise pension saving through a simple, easy-to-understand system compared to the overly complicated proposals of the previous government."
But Labour Treasury spokesman David Hanson warned the changes will hit middle-income families hardest. "Under our plans, no one earning under £130,000 would lose out," he said. "Now everyone's at risk because the Government is taxing on the basis of people's wish to save for a pension, rather than because they are high earners."
And Brendan Barber, the general secretary of the Trades Union Congress, described the plan as a "missed opportunity". "What we need is a much more serious discussion of pensions and tax relief," Mr Barber said.Reuse content