Mini-budget 2022: How the income tax cut means less pension tax relief

When Chancellor Kwasi Kwarteng announced an income tax cut he failed to mention its effect on pensions. We explain how the lowest and highest earners will get less pension tax relief

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Millions of workers will get less pension tax relief from April 2023 as a result of the government’s decision to cut the basic rate and additional rate of income tax.

In his mini-budget Chancellor Kwasi Kwarteng announced the basic rate of income tax from April 2023 would be cut from 20% to 19% while the top rate of income tax for those earning £150,000 or more would be cut from 45% to 40%.

While it means workers will be able to keep more of their earnings, they will also receive less pension tax relief. 

Currently, basic-rate taxpayers get 20% pension tax relief while workers in the top income tax band get pension tax relief at 45%. This will change to 19% and 40% respectively.

We explain how your pension will be affected and how to maximise tax relief on your retirement savings before April 2023.

How will changes to pension tax relief affect my pension?

The changes to income tax mean basic rate tax payers - anyone earning up to £50,270 - will now only get 19% pension tax relief rather than 20%. 

Currently, it costs a worker £80 to invest £100 in their pension. This is because receiving the current 20% pension tax relief results in their pension receiving a £20 top-up from the tax man.

From April 2023, pension tax relief of 19% means they’ll need to pay in £81 (£1 more) to invest £100 in their pension. If the worker continues to pay in £80, their pension will only receive £98.76.

Becky O’Connor, head of pensions and savings, interactive investor (opens in new tab), said: “If some people choose to keep their personal contribution at £80 rather than maintain an overall contribution of £100 a month, this would mean that the overall amount going into their pension would drop slightly, to £98.76, losing £1.24 a month from their pension, or almost £15 a year.

Similarly, an additional-rate taxpayer - anyone earning £150,000 or more - will now only get 40% pension tax relief rather than 45%.

Currently, it costs an additional-rate taxpayer £55 to invest £100 in their pension. This is because receiving the current 45% pension tax relief results in their pension receiving a £45 top-up from the tax man.

From April 2023, pension tax relief of 40% means they’ll need to pay in £60 (£5 more) to invest £100 in your pension.  If the worker continues to pay in £55, their pension will only receive £95.

An extra year’s respite for basic rate taxpayers

While we will see the changes to the income tax rates from April 2023, basic rate taxpayers’ pension schemes that collect pension tax relief via ‘relief at source’ are actually being given an extra ‘transitional’ year to continue to get the 20% relief. 

Former pensions minister Steve Webb was quick to point this out:

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O’Connor explains: “There is an extra year of relief at the current rate of basic income tax until 2024 for pension savers in ‘relief at source’ schemes, such as self-invested personal pension holders. So they will continue to benefit from 20% tax relief on contributions at the basic rate, while paying the lower amount of income tax on basic rate earnings at 19%, for one year.”

Maximise pension tax relief before April 2023

If you’re an additional-rate taxpayer, the remainder of this tax year is your last chance to get 45% tax relief. If you’re in a position to do so, you may want to make extra pension contributions before April 2023 to benefit from the maximum tax relief. 

Former pensions minister Steve Webb said: “There is likely to be a flurry of activity amongst Britain’s highest earners looking to make the most of the chance to get tax relief at 45% on their pension contributions.

“Whilst many high earners are affected by caps on annual and lifetime contributions, they are likely to be taking advice on how best to make the most of this very high rate of relief which ends at the end of this financial year.  We could see thousands of top earners piling into pensions in the coming months.”

Want to know more about the mini-budget? The easing of the 0.75% pension charge cap will affect the majority of workers who stick to their employer’s default fund for their retirement savings. Stamp duty is being scrapped for property values up to £250,000, while first-time buyers will be exempt up to £425,000. Meanwhile, beer, wine and cider duty rises are being cancelled while overseas visitors will be able to shop VAT-free - find out what else the mini budget had in store in our round up

Katie is staff writer at The Money Edit. She was the former staff writer at The Times and The Sunday Times. Her experience includes writing about personal finance, culture, travel and interviews celebrities.  Her investigative work on financial abuse resulted in a number of mortgage prisoners being set free - and a nomination for the Best Personal Finance Story of the Year in the Headlinemoney awards 2021.