How we ALL LOSE if Osborne raids pensions

... not just the rich he claims to be targeting

GEORGE OSBORNE’s plans for a tax raid on pensions could backfire on millions of lower-paid workers he claims he’s trying to help.

The Chancellor is considering a bombshell move to slash pension tax breaks in the budget in three weeks’ time.

He’s been told the £34.3 billion-a-year perk is an expensive and flawed way to encourage saving. Treasury officials are concerned that wealthier savers use the rebates to slash their overall tax bills, while basic-rate taxpayers get barely any benefit.

but Money Mail analysis found all savers would suffer from the changes the Chancellor is considering — not just the rich.

As well as a squeeze on those earning just over £42,385, our research found basic-rate taxpayers could be left tens of thousands of pounds worse off.

The perk under threat is called tax relief. It is effectively a refund of the income tax you’ve already paid — and that helps your pension grow more quickly.

It means that it costs a basic-rate taxpayer just £80 to put £100 into their pension — the missing £20 is added by the Government as a tax refund. For a higher-rate taxpayer, it costs £60 to put £100 in.

The tax is simply deferred until you withdraw the money in retirement. Then, your income is likely to be lower, and so your tax bill often falls, too.

but this system could be torn up in just a few weeks’ time and replaced with something called a Pension Isa.

Any money savers pay into pensions would be taxed like all other income. but withdrawals would be tax-free after the age of 55.

This could deal a devastating blow to the lower paid. According to investment firm Hargreaves Lansdown, a basic-rate taxpayer who saved £250 a month into a pension today would have £183,042 after 25 years, at 5 pc investment growth.

If they saved this same amount into a Pension Isa they’d have £146,433 after 25 years — a difference of £ 36,609. The Government might add a top-up of between 10 pc and 33 pc — but there is no guarantee.

If the top-up were 10 pc, the same saver would build a pot worth £161,076. This would still be £21,966 less than under the current system. At a 20 pc rate, the saver would build up £175,720 — £7,322 less than at present.

Paul Johnson, director of the Institute for Fiscal studies, says: ‘ There is a lot of misunderstanding about why we have tax relief on pensions. It’s perfectly reasonable not to charge people tax when they put money in, and then to tax them when they withdraw it. This is not a subsidy — it’s just making sure tax is paid only once.’

The hidden cost of a Pension Isa would be the death of the 25 pc tax-free lump sum. This is a hugely popular windfall people use to pay off debts or reward a lifetime of graft with a holiday or home extension.

It means you never pay any tax on a quarter of the money going into your fund. With a Pension Isa, you’d already have paid tax when you saved — so the Government would collect an extra £4 billion a year.

steve Webb, the former pensions minister who’s now a director at Royal London, says: ‘This is the real tax bombshell that seems to have gone almost completely unnoticed. It is easy to see why the Chancellor might like to get rid of it.’

Mark Garnier, a Tory member of the Treasury Committee, said on Radio 4’ s Today programme: ‘People need surety in their lives, especially when they come to retirement — so please don’t change it [Mr Osborne].’

Moving to a Pension Isa would also stop the funds being used as a tax time machine.

All savers benefit from the ability to defer tax on income until they are ready to spend that money.

Firstly, because more goes into your pension initially, any investment growth has a bigger impact. secondly, the time machine model helps basic-rate taxpayers manage bills.

The state pension of around £8,000 a year after April 6 leaves about £3,000 of tax-free personal allowance. A pensioner could take this sum from their retirement fund every year without incurring tax. And there is no guarantee future politicians won’t start taxing withdrawals, too — which means savers would be taxed twice.

Another option on the table is to keep pensions as they are but to move to a ‘flat rate’ of tax relief of between 20 pc and 33 pc.

On the face of it, this might seem like a boost for basic-rate taxpayers. With a flat rate of 25 pc, instead of paying £80 to put £100 into a pension, it would cost £75.

but in the long run, this could hurt more than it helps.

According to Royal London, a flat rate of 25 pc would be worth £2 a week extra for basic-rate taxpayers on average — not enough for a cup of coffee at a High street chain.

The Institute for Fiscal studies says a flat rate would set a dangerous precedent. Without a link to income tax, all cash-strapped future governments would be free to nibble away until it disappeared altogether.

A 30 pc rate would save the Treasury just £1.2 billion. so Mr Osborne will be tempted to set it nearer 20 pc, which would save £12 billion a year. The Treasury would pocket most of these savings; only a small amount go to help basic-rate taxpayers.

Experts also say that the Pension Isa and flat rate relief would act as a disincentive to senior staff. The Pensions and Lifetime savings Association says big companies would strip back the generosity of the pensions they offer staff.

Instead of a typical 10 pc boost for every 5 pc a worker puts in the pot, employers might offer just 1 pc — the minimum allowed by law.

Workers are told to start saving for retirement in their early 20s.

but many find they’ve very little to put away at this stage of their careers. First, there’s the struggle to clear student debt and find a house deposit. Then come mortgages and the cost of starting a family.

Often it’s only when workers’ incomes rise in their late 30s and early 40s that they are able to put away meaningful sums for retirement. Under a flat rate, they would find the bonus for saving falls away just when they need it. With a 25 pc flat rate a 35-year-old on £45,000 a year would have to save an extra £148 a month — or work for another two and a half years — to get the same as under the current system.

With a 10 pc Pension Isa top-up they’d have to find an extra £246 or work six years longer, says pension actuaries barnett Waddingham.

A flat rate would also hit those with workers whose earnings vary, such as the self-employed.

someone who saved in good years when they earned £60,000, rather than in bad years when only £20,000 came in, would struggle to build the same pot as an employee on a steady £40,000. In 2012-13 people with incomes over £50,000 made half of the pensions contributions that attracted tax relief — despite only making up 10 pc of the workforce.

Mr Johnson says: ‘The fact that most of this relief goes to higher-rate taxpayers is continually misused: higher-rate taxpayers pay the vast majority of income tax, so of course they benefit more from tax relief.’