Pension tax relief bill hits £38.2bn

The cost of pension tax relief has hit £38bn as the government faces a growing bill to underwrite tax breaks on pensions for all taxpayers, including those paying higher rate tax

Gross pension tax relief in 2015-16 is projected to be £38.2bn, up from £34.9bn in 2014-15, marking a 9.7% increase year on year in the costs of supporting the tax relief.

This is expected to be partly the result of the introduction of automatic enrolment, which has increased the number of individuals saving and thus the total amount saved into workplace pensions in recent years.

Reductions in the annual and lifetime pensions tax allowances were expected to be the main cause of the flattening cost of pensions tax relief between 2010-11 and 2014-15.

Contributions to occupational schemes (employee and employer) account for 60% of the total relief; this has fallen from 65% in 2010-11 and almost 70% in 2005-06.

The latest figures show that annual pension contributions exceeded pre-crash levels for the first time in 2014-15, with a total of £24.3bn contributed to personal pensions in 2015-16, higher than both the £20.3bn in 2014-15, and the previous peak of £20.9bn contributed in 2007-08 ahead of the financial crisis and downturn in the UK economy.

Contributions to personal pensions by employers and employees account for about 18% of the total relief and contributions by the self employed a further 2%. The remainder of the cost of relief is relief on investment income.

Tax received by the government on pensions in payment in 2015-16 was £13.4bn; the highest level since these statistics began, and reflecting the general year-on-year increase seen since 2009-10.

The number of individuals contributing to a personal pension increased to 9m in 2015-16, up nearly two million from the 7.9m paying into pensions in 2014-15.

There are currently 3.7m more individuals contributing to personal pensions with the increase attributable to the effects of automatic enrolment pensions.

Annual average contributions per individual grew between 2006-07 and 2011-12 (peaking at £3,690 per individual), before falling to £2,540 per individual in 2014-15. The average contribution was £2,690 in the most recent year.

Tax on withdrawals

Individuals with total pension savings of less than £30,000 are allowed to withdraw the entire amount out as a lump sum. If the right to the pension has not yet arisen (ie, the pension is not in payment or has not been voluntarily deferred by the pensioner), the first 25% of these amounts are tax free.

All other payments are taxed as pension income at the individual’s marginal rate and free from NICs. These are known as the trivial commutation rules.

Individuals with funds above £30,000 but below the lifetime allowance (LTA, £1m in 2017-18) can also withdraw tax-free up to 25% of their pension savings after the age of 55. This part lump sum option is referred to as ‘commutation’ and the majority of pensioners take advantage of it.

For individuals with a regular pension income of less than £12,000, the remainder must be taken as a scheme pension, an annuity or through income withdrawals from a drawdown pension fund. The fund does not have to be converted into an annuity but no more than 150% of a comparable annuity can be withdrawn each year, based on tables produced by the Government Actuary's Department (GAD).

Individuals with pension funds that include one or more funds in occupational scheme of value less than £10,000 are allowed to take the entire amounts in these schemes out as a lump sum no matter how large their total pension savings.

Any funds above the lifetime allowance (LTA) that are taken out as a lump sum are taxed at 55%; and any funds that are used to provide a pension are taxed at 25% (the pension income is then taxed at the individual’s marginal tax rate).

The report HMRC Personal Pensions: contributions and reliefs statistics is available here

Report by Sara White

Essential reading

To read more about pensions and the lifetime allowance, read Kay Ingram’s pension series


To read more about pensions and the lifetime allowance, read Kay Ingram’s pension series 

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