Pension tax breaks slashed for big earners

The tax breaks high earners get on pension savings are to be cut dramatically to save £4 billion a year, it was announced today.

The amount people can save tax-free into a pension each year is being slashed from £255,000 to £50,000 from next April.

But those on high salaries will continue to receive tax relief on pension savings at the highest rate at which they pay income tax.

The Government also plans to reduce the lifetime pensions savings allowance that benefits from tax relief from £1.8 million to £1.5 million from April 2012.

The reforms replace the complex changes to the regime proposed by the previous government, under which people earning more than £150,000 would have had the level of tax relief they received gradually reduced to 20%, despite the fact that they paid income tax at 50%.

The previous proposals sparked outrage from the pensions industry, with commentators warning that the rules would be complex to administer and might put people off saving through a pension.

Today's measures received a broad welcome, although there were concerns that some people on middle incomes who had defined benefit schemes might face an unexpected tax bill.

As part of the reforms, the Government is raising the rate at which increases to the pensions accrued in defined benefit schemes are valued.

This means that someone whose pension entitlement rose by more than £3,125 a year could be hit with a tax bill.

To help protect workers on low and moderate incomes, people who exceed the annual allowance because of one-off spikes in pension accrual will be allowed to offset it against their unused allowance from the previous three years.

Exemptions will also be made for people retiring early on grounds of ill-health.

The Government also plans to hold a consultation on allowing people to meet any tax charges they face out of their pensions.

It estimates the measures will affect only around 100,000 people, 80% of whom earn more than £100,000 a year.

Financial Secretary to the Treasury Mark Hoban said: "We have abandoned the previous government's complex proposals and developed a solution that will help to tackle the deficit but not hit those on low and moderate incomes. We have taken a tough but fair decision.

"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."

The changes were welcomed by industry bodies and business groups.

Joanne Segars, chief executive of the National Association of Pension Funds, said: "Today's announcement is a welcome and pragmatic approach that will help to ensure that saving through a pension remains tax-incentivised.

"Increasing the annual allowance to £50,000 will help to ensure that modest earners with long periods of pensionable service are not caught with an unintended tax charge."

John Cridland, CBI deputy director-general, said: "Today's announcement is not as bad as feared. The Government had considered making the annual allowance as low as £30,000.

"It rightly heeded warnings about the impact that restrictive regimes can have on pension saving, and these new proposals are a significant improvement on the approach proposed by the previous government, which was simply unworkable."

But others pointed out potential problems with the new regime.

Marc Hommel, pensions partner at PricewaterhouseCoopers, said: "The current Government estimate is that 100,000 people will be affected but this could potentially double as many more people could be caught in future if the annual and lifetime allowances remain frozen and inflation takes off."

Others expressed concerns about the impact the changes would have on the self-employed, whose incomes are more irregular, as well as the short timeframe in which the changes would be implemented.

The announcement comes a week after the Government hit the middle-classes by announcing that it would no longer pay child benefit to higher-rate taxpayers from 2013.