For years, there has been a debate about whether pension tax relief should be cut, altered or scrapped completely.
Currently, if you pay into a pension, you get relief at whatever income tax rate you pay, so higher-rate payers get bigger tax relief.
Some experts say that makes the system unfair and disproportionately rewards people who are already best placed to save whilst others warn that changing it could punish pension saving.
Shorts
With Andy Burnham’s Government preparing its first Budget and Chancellor John Healey under pressure to find money for Labour’s spending plans, we hear from two experts on whether a flat rate of pension tax relief would make the system fairer – or simply create a new set of problems.
For a flat rate: Sir Steve Webb and Ros Altmann
Steve Webb, former pensions minister and now a partner at LCP, argues that having a flat rate on tax relief is a good idea.
He said: “There’s no doubt that the benefits of pension tax relief are very unevenly shared. Those on the highest incomes tend to pay larger amounts into pensions and also get tax relief at a higher marginal rate. This is a kind of ‘double whammy’ which leads them to eat up the lion’s share of tax relief.”
As relief is linked to an individual’s marginal tax rate, someone paying 40 per cent tax gets a bigger upfront benefit than someone paying 20 per cent.
In 2024-25, the total cost of income tax relief for people paying into defined contribution (DC) pensions through “relief at source” – where providers automatically claim tax relief and add to your pot – was £7bn, with two-thirds going to higher and additional-rate taxpayers, despite those groups making up only 20 per cent of taxpayers.
Webb added: “In theory, therefore, a move to some form of ‘flat-rate’ relief might be attractive. It would take money away from those probably most able to cope and redistribute towards those who probably need more help to get their pension pot up to a decent level.”
A flat rate could, for example, mean everyone receives 30 per cent relief. Basic-rate taxpayers would get more than under the current system, while higher-rate taxpayers would get less than they do currently.
A 20 per cent tax relief is equivalent to a 25 per cent government bonus on a saver’s own contribution, and 40 per cent relief is equivalent to a 66 per cent bonus.
Former pensions minister Ros Altmann makes a similar argument.
She said: “Obviously with a progressive tax system, using tax relief as an incentive mechanism will be more generous to those on higher incomes who save a higher rate of tax.
“Those on higher incomes can often more readily afford to put more money into a pension. So higher earners get more on both counts.”
She also argues the existing system is difficult for ordinary savers to understand.
“The main problem with tax relief – apart from the massive £70bn cost – is that most people don’t know how much they get added to their own contributions by all taxpayers. And many people don’t realise how generous it is so as an incentive it is quite inefficient.”
Webb said it would take years to implement any change.
“There is no ‘silver bullet’ solution which would reallocate this money without serious political and administrative challenges.
“Any change could take years to implement and would create some large losses amongst a vocal section of society.
“This might be bearable for the Government if it meant a lot of extra tax revenue to boost the pensions of lower earners or for public services. But in reality, the gap between announcement and implementation would undoubtedly take us beyond the next general election, meaning all the political heat and none of the money.”
Against a flat rate of pension tax relief: Tom Selby
Meanwhile, Tom Selby, director of public policy at AJ Bell, says the practical consequences could be severe.
He said: “Anyone advocating for a shift to a flat rate of pension tax relief needs to address the practical and political implications of the proposal.
“In particular, how do you apply a flat rate of income tax relief to defined benefit (DB) schemes, where tax relief is provided automatically on contributions?”
Applying a flat rate would mean calculating individual tax values based on employer contributions, which is technically very difficult to do for DB schemes (which guarantee an income for life and are common in the public sector).
If the tax relief drops while a worker pays a 40 or 45 per cent income tax rate, they face an unexpected tax bill on their pension growth.
Selby added: “If we assume a pension tax relief flat rate would be set at 20 per cent to 30 per cent, that would effectively amount to a colossal tax charge on millions of public sector workers paying into a pension and earning over £50,000. It would be a pensions punishment of epic proportions.”
The proposal has repeatedly caused alarm among doctors and other public sector workers.
The British Medical Association warned in 2024 that a flat rate could worsen pension taxation in the NHS and potentially encourage early retirement.
Selby also argues that reducing upfront relief could ultimately mean less money being saved into pensions, adding: “One would have to assume that a tax relief raid of this nature would be aimed at raising cash for the Exchequer.
“It would therefore naturally result in less money going into private pensions, making it more likely that people will end up short of money in later life, placing more pressure on the state in the future.
“Fundamentally, this is an idea that only really works in the minds of academics at think-tanks. Once it meets the real world, it falls apart quite quickly.”
