Chancellor Rishi Sunak’s rumoured move to create a flat rate on pensions tax relief at 25 per cent could leave a “big dent” in top earners’ pension pots, according to Aegon.

A government source told The Times that the change was viewed as "a matter of fairness" by the Chancellor, adding that he was "very attracted" to the idea of a flat rate.

The Resolution Foundation think tank said the changes could save the government £4bn per year.

Changes to the current system could be signalled in Sunak's spending review on Wednesday (25 November) but will likely not come into force until the March Budget, and could be delayed even further into 2021.

The current system sees basic rate taxpayers receive 20 per cent tax relief, higher rate taxpayers receiving 40 per cent tax relief and those who are paid £150,000 or more per year benefitting from 45 per cent tax relief.

To illustrate how the new system would work, Aegon pointed out that, a basic rate taxpayer paying £100 a month into their defined contribution pension would see this topped up to £133.33 rather than the current £125, though a higher rate taxpayer who currently sees their £100 increased to £166.66 would see this reduced to £133.33.

Aegon pensions director, Steven Cameron, said the rumoured new system “is seen by many as a fairer way of sharing this government incentive across people of all earnings bands but would also likely produce a cost saving for the Treasury”.

He added: “It would be good news for basic rate taxpayers who’d receive a more generous bonus but would create a big dent in the future pension pots of higher and additional rate taxpayers unless they increased their contributions.”

To illustrate the effects of the change over the long term, Aegon noted that a basic rate taxpayer on average earnings of £27,000 who paid 4 per cent out of take-home pay from age 22 through to their current state pension age of 68 could see the fund from their contributions increase from £319,000 to £340,000.

A higher rate taxpayer aged 35 earning £60,000 who sent the same 4 per cent from take home pay to their retirement savings would see the fund from their contributions fall from £424,000 to £339,000, meaning that they would need to increase their contribution out of take-home pay to 5 per cent to make up the difference.

Cameron stated that the changes, along with the fact that individuals can take on quarter of their pension proceeds tax free, meant pensions would be “an even better deal for those paying basic rate income tax”.

He continued: “Most individuals paying higher rate tax when working pay basic rate income tax once they’ve retired. For them, pensions would still be very tax efficient under a flat rate 25 per cent tax relief system.

“The group for whom it’s less clear are those who might be higher rate taxpayers in retirement, who might need to weigh up the pros and cons. But like all employees who contribute to a workplace pension, they would also receive valuable employer contributions offering an additional attraction.

“Before implementing a move to a flat rate of pensions tax relief, more thinking is needed on how this would work for those contributing to a defined benefit or final salary scheme.

"Here, the pension benefits they receive are based on their final or career average salary and not on the amount their contributions grow to after tax relief and investment growth.

“For consistency with those contributing to defined contribution schemes, higher and additional rate taxpayers in defined benefit schemes might see their and their employer’s contributions taxed as a benefit in kind, increasing their tax bills.”

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