This morning’s publication of estimates for 2018/19 and 2019/20 for the cost of pension tax relief should not be used by the Chancellor as an excuse for a ‘raid’ on tax relief in next month’s Budget, according to consultants LCP. 

Although the figures show that the gross cost of tax relief has risen from £36.9bn in 2017/18 to £41.3bn in 2019/20, a large part of the increase will have been due to the rise in mandatory contributions under automatic enrolment.  These went up from 2% in 2017/18 to 8% in 2019/20. In short, the rise in the cost of tax relief reflects millions of ‘ordinary’ savers saving more, and should be celebrated rather than used as an excuse for cutting back.

The most recent figures previously available showed the total cost of income tax relief on pension savings made in 2017/18.  Today’s figures provide revised estimates for 2017/18 and new figures for 2018/19 and 2019/20. They show that over the two years to 2019/20, the total gross cost of tax relief as measured by HMRC has risen by £4.4bn to £41.3bn. 

Out of the total of £41.3 bn quoted cost of pension tax relief, nearly two thirds is on the contributions made by employers into occupational and personal pensions for their employees.  By contrast, pension saving among the self-employed is at such a low and falling level that tax breaks on pension saving by the self-employed accounts for less than 1% of the total cost of tax relief.  The statistics also include £7.3 billion because investment income generated by pension funds is not taxed within the pension pot (just like ISA savings). 

The figures also show:

• The amount of tax collected from pensions currently in payment rose from £18.3 bn to £19.2 bn over the latest two years;
• The fact that employer contributions to pensions are not subject to National Insurance cost the Treasury is quoted at around £20 bn in 2019/20;

The growth in the cost of pension tax relief is affected by a range of factors, notably the increase in statutory minimum pension contributions under automatic enrolment from 2% in 2017/18 to 8% in 2019/20 which will have led to a growth in the cost of the relief.  More than half of all workers brought in to pension saving as a result of automatic enrolment are estimated to have contributions made at the statutory minimum level, which means that the cost of tax relief on contributions rises significantly when minimum statutory contribution levels rise.

However, according to pensions experts at LCP, despite the headline £41.3 billion quoted cost of pension tax relief, this is not simply a pot of money into which a cash-strapped Chancellor can easily dip.  Based on recent work carried out by the Pensions and Lifetime Savings Association on statistics for an earlier year LCP estimates that:

• Around £1 in £7 of the tax relief bill relates to a typical £10-£15bn per year being paid by companies to clear deficits in their Defined Benefit (DB) pension schemes; applying tax in some way on these contributions would simply penalise companies who are being pressed by government and regulators to tackle shortfalls in their pension schemes;
• Around £1 in £3 of the cost of pension tax relief relates to public sector DB schemes such as those for teachers, nurses and civil servants, and most of this is on employer contributions;  in the private sector, members can put off a big pension tax charge by asking the scheme to pay the bill now in return for a lower pension later;  but in these ‘unfunded’ public sector schemes there is no ‘pot’ from which the scheme could pay;  so either public servants would face large up front tax bills or the Treasury would get little or no upfront revenue from taxing contributions to these schemes;
• Current levels of pension saving are widely agreed to be inadequate, and further cuts to pension tax relief could undermine pension saving; with traditional Defined Benefit schemes largely closed in the private sector and contribution levels into newer Defined Contribution schemes still at relatively low levels, action is needed to boost overall pension saving rather than to discourage it.

Commenting, Karen Goldschmidt, pension tax specialist at consultants LCP said:

“The Chancellor will undoubtedly be looking with great interest at the quoted headline figure of £41.3 billion for the ‘cost’ of pension tax relief.  But these figures provide no excuse for a Budget raid on pension tax relief.  The growth reflects millions more workers savings towards their retirement and should be welcomed, not used as an excuse for cuts.  In addition, a large part of the headline cost of tax relief relates to the cost of public service schemes, where a reduction in relief would either result in big tax bills for public servants or generate little up-front revenue for the government. The tax relief figure also includes the vital contributions which firms are making to cover the shortfalls in their pension schemes which the government should be encouraging rather than taxing more heavily.  Overall we need more pension saving, not less, and a raid on pension tax relief would send entirely the wrong signal to millions of people who have just started out on their pension saving journey”.

LCP also point out that these statistics should be treated with considerable caution for two main reasons:

• HMRC themselves acknowledge in the notes that “costs are subject to large revisions and have a particularly wide margin of error”
• The way in which the cost of relief is calculated is open to question.  For example, the billions of pounds which companies pay to plug deficits in their pension scheme are counted in the figures but do not actually relate to individual members.  A somewhat arbitrary assumption has to be made about the income tax rates to be used to convert those aggregate contribution figures into a cost of tax relief figure.  HMRC replies to inquiries from LCP about the methods used suggest that the way this is done could lead to an upward bias in the figures.

Notes to editors: 

1. In July 2021 the Pensions and Lifetime Savings Association presented analysis of the breakdown of the total cost of pension tax relief, at that time estimated at £37.2bn.  PLSA found that £5.7bn related to ‘deficit repair contributions’ made by employers and £12.6bn related to public service pension accrual. 
2. HMRC replies to LCP queries around these statistics available on request. 
3. The new table can be found here