Kwarteng’s tax cut for City’s wealthiest could sting pension savings

The City’s wealthiest are set to benefit the most from cuts to income tax in chancellor Kwasi Kwarteng’s mini-budget, but there’s a sting in the deal for pension savings.

Slashing the income tax rate to 40% from 45% for those who earn more than £150,000 a year – 1.9% of the UK’s population — came alongside the removal of the bonus cap for bankers as Kwarteng sent a clear pro-growth message to the City.

But the tax cut, which takes effect on 6 April 2023, will also hit higher earners’ pensions, according to Rachael Griffin, tax and financial planning expert at Quilter.

Griffin warned high earners could face a corresponding cut to the amount of tax relief they can claim on their pension savings.

READ Banker bonus cap scrapped as Kwarteng reveals ‘growth plan’

Scrapping the additional-rate tax band could harm higher earners’ pension savings as under the current rules they can claim tax relief on pension contributions at their nominal income tax rate.

“It could mean their pension tax relief falls from 45% to 40%, subject to the tapered annual allowance,” she said.

In documents published after the 23 September announcement, the Treasury said higher tax rates “damage UK competitiveness” and “reduce the incentive to work, invest, and start a business”. The department also noted the previous income tax rate was higher than countries like the US, Norway and Italy.

Kwarteng will be hoping that reducing the burden on top earners will increase the tax take for the Treasury, Griffin said.

Those earning above £150,000 “will significantly reduce their income tax bill”, she said.

“Someone earning £175,000 will take home an additional £1,250 a year, which increases to £3,280 if you include the government’s U-turn on the 1.25 percentage point national insurance hike,” said Griffin.

Meanwhile, someone earning £250,000 will take home £8,000 more from the reforms, she noted.

“Those earning £500,000 a year will have a whopping £17,500 in take-home pay from the abolition of the 45% rate, which ups to £23,592 with the [national insurance] reversal included.”

The total income tax paid by UK taxpayers has almost doubled in the past 20 years, from £324.7bn in 2002/3 to £633.4bn in 2019/20. The number of additional-rate taxpayers has risen the fastest.

“When the freeze to the personal allowance was announced last year, the Office for Budget Responsibility calculated that the freeze would push one million taxpayers into the higher tax bracket,”  Griffin said. “It could take a couple of years before we truly see the impact of the abolition of the higher rate tax band on the economy. For Truss and Kwarteng this may prove not be time enough as voters will have their say at the polls no later than January 2025.”

She said Kwarteng is backing the theory that you can cut taxes to increase revenue after the pandemic and energy crisis left a fiscal black hole for the government.

“He may be proved to be correct as some people would no longer keep their income down to avoid the additional rate. Truss and Kwarteng are sending a Conservative signal that they want people to do well,” she said.

The tax cut for high earners could also force awkward decisions around deferral of bonuses and dividends, Blick Rothenberg audit partner Andrew Sanford said, at a time when some could do with the income boost due to soaring inflation and the cost-of-living crisis. 

“A fall in the higher rate tax band from 45% to 40% means that bonuses and dividends will be delayed until the new tax year to pay the lower rate of tax,” he said. “This means that there will be a one-off significant fall in tax receipts next year from income tax receipts, at the same time [Kwarteng] is funding utility bills. This must mean more debt and the risk of higher interest rates and worsening exchange rates.” 

To contact the author of this story with feedback or news, email Penny Sukhraj

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