Should £720 a year pension tax relief for non-earners be raised?

The pension contribution limit for non-earners has been frozen at £3,600 for two decades, curbing what people with no current income can save for old age.

They can put away up to £2,880 a year, to gain a maximum £720 or 20 per cent in tax relief from the Government into their retirement pot.

Finance experts say the Government should look at raising the limit to help people, mostly women doing unpaid caring work, to boost their pensions.

Financial firm Aegon says if the limit had been increased with inflation since 2001 it would be £6,335, and if raised in line with average earnings it would now stand at £6,421.

By comparison, the standard annual allowance for earners is currently £40,000, including individual and employer contributions and the tax relief top-up.

>>>>What other pension tax rules do you need to know? Find out below

Aegon says increasing the annual limit for non earners will improve pension saving among this group, especially women, helping to close the gender pension gap

It calculates that if an individual takes a five-year break from work at age 30, and saves £6,400 compared to £3,600 into a personal pension during this time, they could have an additional £62,800 in their fund by state pension age.

That assumes investment growth of 4.25 per cent after charges over 38 years.

Who uses the non-earner pension tax break?

You do need to be well enough off to have savings available to divert into a pension.

However, the following groups tend to benefit from this pension saving perk, explains Aegon.

Kate Smith of Aegon: ‘Increasing awareness of this little-known allowance may encourage individuals to make use of it to pay into their partner’s pensions’

Women on maternity leave: Employer and employee contributions continue during paid maternity leave. The £3,600 rule can be used to plug any pension savings gaps in unpaid maternity leave.

Parents raising their children: Individuals can continue to build up pensions by paying other savings into them. A working partner can make pension contributions on behalf of their spouse.

Children: Parents can set up a junior self-invested personal pension (Sipp) for their child. The earlier you start pension saving, the longer the fund has to benefit from compounding.

Carers: An individual can continue to build up pensions if they leave employment to take on full time caring responsibilities, by using other savings. A working partner can also make pension contributions on their behalf up to the limit.

Others out of work: The rule is useful for anyone who takes time out of the workplace for other reasons, such as a career break, illness or unemployment.

What do pension experts say?

‘While the £3,600 pension contribution rule is helpful for those with no earnings to build up a pension, the limit has been frozen for the last two decades,’ says Kate Smith, head of pensions at Aegon.

‘Increasing this in line with either inflation or earnings could substantially help the pension saving for those without earnings or who take career breaks who often lag behind in their retirement savings.

‘With indexation against wage growth or inflation, the limit could be around £6,400 today.

‘Increasing the limit to around this level could particularly help address the gender pensions gap which still persists as women take time out of work for childcare or wider family responsibilities.

‘Increasing the amount and awareness of this little-known allowance may also encourage individuals to make use of it to pay into their partner’s pension.’

Former Pensions Minister Steve Webb, who is now a partner at pension consultants LCP and This is Money columnist, says: ‘When limits on pension contributions have been unchanged for decades there is a strong case for reviewing what they are for and whether they are set at the right level.

‘One group likely to be affected by this low limit is parents who may become non-earners owing to family responsibilities.

‘In a two-parent family there may be one person still in paid work on a good wage who would like to top up a partner’s pension but comes up against this very low limit.

‘In practice it is more likely to be women rather than men who lose out on pensions during periods out of paid work, so an increase in this limit could help to protect women’s pensions and reduce the pensions gender gap.

‘The Government should review this limit and consider raising it to a far more realistic level.’

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, says: ‘This allowance plays an important role in ensuring people who are not earning are not locked out of pensions.

‘Not only can they contribute to their pension from their own savings and benefit from tax relief and investment growth, they can also receive contributions from someone else – for instance a spouse or family member.

‘It can be of particular use to those staying at home to look after children in helping them to keep their pensions topped up until they can return to work.

‘For those who don’t think they will return to the workplace it can keep their retirement planning on track.

‘It can also be very tax efficient should one partner max out their own contributions during the tax year as they can top up their partner’s pension instead.

‘While an increase in the limit would be welcomed by many it is unlikely to happen in the current environment.

‘It is also worth saying that even the current limit is a hefty sum to find each month and so any increase in this limit would primarily benefit those who are better off.’

The Treasury was asked for comment but did not respond before publication.

What other pension tax rules do you need to know about? 

Pension tax relief: This allows everyone to save for retirement out of untaxed income.

You receive rebates, effectively free cash from the Government paid into your pension, based on your income tax rate of 20 per cent, 40 per cent or 45 per cent.

Despite heavy speculation ahead of practically every Budget, the Government has made no move to change the rules to grab the money and use it for other priorities, so far.

Annual allowance: The standard amount you can put in your pension every year and qualify for tax relief – including your own and your employer’s contributions, and the tax relief itself – is £40,000.

The rules are more complicated for higher earners, whose annual allowance is ‘tapered’ down to either £10,000 or £4,000.

The threshold income level, where people’s annual earnings start being calculated for the purposes of pension tax relief, is £200,000.

But the annual allowance starts being tapered down for people with an adjusted income level – which includes pension contributions – of £240,000.

For those with adjusted income of £300,000 or more, the taper will reduce the annual allowance to just £4,000. Read more here. 

Lifetime allowance: This is how much you can save into a pension and get tax relief in total, and is currently £1,073,100. The Chancellor intends to freeze it at the level until 2025/26. Read more here. 

Money purchase annual allowance: People who start tapping pots for any amount over and above their 25 per cent tax free lump sum are only able to put away £4,000 a year and still automatically qualify for tax relief from then onward. Read more here. 

Carry forward: You can use up unused annual allowance from the three previous tax years, under certain conditions.

You need to have been a member of a pension scheme during the years you intend to ‘carry forward’ annual allowance from, although you don’t need to have paid anything into it.

This often catches out people, such as the self-employed, who have neglected retirement planning and are trying to build up a pension from scratch.

You must also use up your entire annual allowance first for the year  in which you want to do carry forward, and you have to go back to the earliest of the three years and use up the allowance from then first. Read more here.