What do income tax cuts mean for pension savers?

Income tax cuts come with ‘a stab in the tail’ for pension savers who will see their premiums cut by the government, financial experts say.

The reduction of the base rate from 20 percent to 19 percent and the abolition of the top rate of 45 percent benefits taxpayers in terms of wages home, but has a knock-on effect on pensions.

Taxpayers will no longer get a 25 percent automatic top-up on money deposited into pensions to cover the base rate tax credit – they will be returned to where they were before 20 percent tax was imposed – and will instead pay a lower increase of 23 percent. see percent.

It could lead to a rush of additional pension contributions, especially from higher earners with the highest profits, ahead of changes in April 2023, although some base-rate taxpayers will have an extra year of breathing room due to transitional technical arrangements.

Thanks to the tax reduction for pensions, everyone can save for their pension from untaxed income. That means you get a bigger sweetener the more you earn.

The discount or ‘top-up’ is based on personal income tax rates – that is 20 percent, 40 percent or 45 percent, until Chancellor Kwasi Kwarteng’s changes take effect.

“The reduction in the basic income tax rate from 20 percent to 19 percent is good news for millions of people,” said Steven Cameron, director of pensions at Aegon.

‘There is a small sting in the tail with regard to pension contributions. Individuals receive a “tax credit” based on their “top marginal” income tax rate.

‘Currently, the ‘net’ cost for an individual to invest £100 in their pension is £80 as on paying 20 percent income tax their pension gets a supplement of £20 from the IRS.

Going forward, a 19 per cent income tax rate means you have to pay £81 from taking it home to have £100 invested in your pension. So if individuals continue to pay £80, their pension will benefit from a slightly lower £98.75.

“While the income tax rate change is from April 2023, pension plans that collect a retirement tax credit for their members using what is referred to as a ‘withholding reduction’ will be granted an additional year to continue collecting the 20 percent rate. ‘

Meanwhile, the abolition of the additional 45 percent tax rate for those earning more than £150,000 will also affect their tax credits, and they may want to increase their contributions while they still can, Cameron said.

‘Currently, taxpayers with a high addition rate can receive a 45 percent tax reduction. In other words, a contribution of £550 from take-home pay becomes £1000 when invested in a pension. In the future, the top marginal rate will be 40 percent, so the same £1000 in a pension will cost £600 of taking it home.

‘Anyone who is able to do so may want to pay extra pension contributions before April 2023 in order to enjoy maximum tax benefits. We recommend that you seek professional financial advice.’

Cameron notes that even with slightly lower tax deductions, pensions still remain a particularly tax-efficient investment, and those with work arrangements also receive a generous supplement from their employers.

James Jones-Tinsley, pension specialist at Barnett Waddingham, says: ‘For consumers, cutting income taxes to 19 percent is a double-edged sword.

‘It’s a direct income gain with a long-term sting in the tail of a smaller pension. The one percent loss may sound insignificant, but it gets bigger over a working life — as Einstein said, it’s “the eighth wonder of the world,” and those who don’t understand it pay the price.

‘Individuals must now increase their personal contributions to stand still; this may not be a tempting prospect with rising interest rates and rising inflation.

“Nothing in the Chancellor’s speech spoke of the UK’s looming pension crisis – there’s only so long the government can kick this off the road.”

Claire Trott, a pension expert at St. James’s Place, says: “The announcement that the income tax cut from 1 percent of the base rate to 19 percent is being brought forward may prompt people to consider whether now is the time to maximize pension contributions or when keeping fire makes more sense.

“But for those paying extra taxes, the rest of this year is the last chance to get a 45 percent tax cut. That said, they won’t pay a 45 percent tax next year.

“The overall tax credit for higher rate taxpayers will likely remain the same, but if premiums are paid for a personal pension, less will go to retirement and more to your pocket when the reduction occurs.

“This is not the same for most occupational retirement plans where the premium is paid before tax.

‘However, for people with a low income, the reduction in the exemption will be a reduction in their pensions. For a non-taxpayer, they currently get a 20 percent tax credit, up to their income or £3,600 if more.

‘If the basic rate falls for some, it will be reduced to 19 percent, although there is a transition period for personal pensions.

“This affects those least able to save the hardest. For those who participate in automatic enrollment schemes, depending on their structure, this can mean higher contributions from salary packages.’

AJ Bell says that for base rate taxpayers, cutting income taxes from 20 percent to 19 percent will lower the effective retirement savings bonus provided by tax credits from 25 percent to about 23 percent.

It explains that for overdraft payers, the reduction in the income tax rate from 45 percent to 40 percent will reduce this savings bonus from about 82 percent to 66 percent.

The office provides the following examples, assuming that the saver is affiliated with a source scheme. It notes that participants in net pay plans will automatically receive the full amount of tax relief unless they are a very low earner.

Under the current system:

• Base rate taxpayer – pays in £80, gets £100 in their pension (20% tax credit, 25% bonus)

• Higher rate taxpayer – pays £80, gets £100 in pension, claims £20 back (40% exemption, 66% bonus)

• Additional taxpayer – pays £80, gets £100 in pension, claims £25 back (45% exemption, 82% bonus)

Under new tax rates – once fully implemented:

• Taxpayer base rate – pays £81, gets £100 in pension (19% tax credit, 23% bonus)

• Higher rate taxpayer – pays £81, gets £100 in pension, claims £21 back (40% exemption, 66% bonus)

• Additional Taxpayer – pays £81, gets £100 in pension, claims £21 back (40% exemption, 66% bonus)