Kwarteng’s 45p tax rate U-turn: pension tax relief impact explained

Chancellor Kwasi Kwarteng’s dramatic volte-face on scrapping the 45p rate of income tax will have a knock-on effect for retirement saving incentives.

Pension tax relief is granted at your marginal rate of income tax, meaning lowering the top rate of income tax by 5p would reduce the tax relief higher earners could claim.

The decision to abolish the 45p additional rate of income tax had led to predictions of a tax relief ‘gold rush’, with those set to see their top ups reduced in April 2023 piling into pensions ahead of the deadline.

Today’s U-turn means that once fully implemented:

• • Basic-rate taxpayers will be entitled to 19% pension tax relief, equal to a 23% saving bonus)
  • Higher-rate taxpayers will be entitled to 40% tax relief, equal to a 66% bonus
  • Additional-rate taxpayers will be entitled to 45% tax relief, equal to an 82% bonus

Tom Selby, head of retirement policy at AJ Bell, comments:

“If Watership Down taught us anything, it’s that the life of a rabbit can be truly brutal. But even Richard Adams would have struggled to write such a quick and painful end as the one suffered by Chancellor Kwasi Kwarteng’s ‘rabbit out of the hat’ move to scrap the 45p top rate of tax.

“In the end it was politics that did for the measure, with the Government facing a significant revolt from its own backbenches over the move, which would have seen taxes for high earners cut at a time when millions of households already facing an inflation squeeze are braced for further pain from rising mortgage costs.

“The U-turn also ends the possibility of a pension tax relief ‘gold rush’ from higher earners, who would have had until April next year to contribute to their retirement pots and take advantage of 45% tax relief. Under Kwarteng’s proposals, the pension saving ‘bonus’ for additional-rate taxpayers provided by tax relief would have reduced from 82% to 66%.

“The clock is still ticking for basic-rate taxpayers, however. Those in ‘net pay’ pension schemes have until April 2023 to pay into their pension and benefit from 20% tax relief. After this point, the tax relief top up will be reduced to 19%, in line with the planned income tax reduction.

“Those in ‘relief at source’ schemes, where basic-rate tax relief is paid automatically, will have an extra year before their tax relief is reduced from 20% to 19%.”