Put £2 in your pension and get £1 free, suggests minister

Emma Woollacott
A2CWRN Royalty free photograph of pension business headline in UK financial times pension; retirement; old; age; pensioner; prop
A2CWRN Royalty free photograph of pension business headline in UK financial times pension; retirement; old; age; pensioner; prop

Pensions minister Steve Webb has suggested scrapping pensions tax relief for higher earners and bringing in a single flat rate, in a move that could benefit basic rate taxpayers.

Currently, pension tax relief is based on income tax rates, and stands at 20%, 40% or 45%. But with a flat rate tax rebate of 33%, everybody would get a 50p rebate for each £1 they save towards their pension, giving them £1.50 in total.

It means that people paying the 20% rate of tax would see their rebate go up by £250 for every £1,000 paid in, while those paying 40% and 45% would get £167 and £318 less respectively.

Calculate your pension income options

Last week, Webb said he believed the current system didn't give enough of an incentive for people to save - "other than the very rich".

"It is hard to understand why we do it the way we do it; 33% might have an impact," he said.

Webb's views don't reflect official Liberal Democrat policy, with the party having said it merely plans to establish a review and consider a single flat rate. And a level of 33%, figures from independent think tank the Pensions Policy Institute indicate, tax income could fall overall.

Webb, however, suggests that his proposal could end up being tax neutral if it discouraged workers from using salary sacrifice schemes.

His remarks have been welcomed by the Centre for Policy Studies think tank, which recently produced a report advocating just this move.

"Today's framework of tax relief is faced with a fundamental conundrum. Given that income tax is progressive, then tax relief is regressive, so much so that it is more of a personal tax management tool for the wealthy than an incentive to save," says report author Michael Johnson.

"There is plenty of evidence that the wealthy will save anyway, regardless of a 40% or 45% tax relief."

Calculate your pension income options

To keep those richer savers happy, Webb also suggested scrapping the cap on ther lifetime allowance, which currently limits tax relief on savings to £1.25 million.

"If these proposals for a flat-rate tax relief on pension contributions go through we'll see a more streamlined system, and this should make it easier for people to understand how tax relief works," says Karen Barrett, chief executive of financial advisor search site unbiased.co.uk.

"Our research with Prudential found that an additional £2.9 billion could be saved annually in tax as a result of more people taking better advantage of the pension tax breaks available."

Read more on AOL Money:
Pensions vs ISAs: the pros and cons after reform

Will pension freedom create double trouble for taxpayers?

Why Webb's 'sell your pension' plan won't work

Should UK Pensions Be Modeled on Holland's?
Should UK Pensions Be Modeled on Holland's?