Among the inevitable Autumn Statement rumours that begin circulating around this time of year, writes Jessica List, it is hardly surprising contribution tax relief has been taking centre stage.
New chancellor Philip Hammond hinted recently he won’t use his first Autumn Statement to make dramatic changes to legislation. This announcement came a bit too late, however, to stem the tide of rumours that inevitably begins around this time of year.
It is hardly surprising that contribution tax relief is taking centre stage – after all, it was extensively discussed, but never actually amended, under the watch of Hammond’s predecessor George Osborne.
One idea the government has reportedly considered in recent weeks, is to scrap tax relief in favour of a ‘top-up’ system based on an individual’s age. For each £1 contributed, an individual would receive a top-up of £1, less their age in pence. For example, a 30 year old contributing £100 would receive a £70 top-up.
It’s certainly an interesting concept, but the more I think about it, the more concerns and questions I have.
On the one hand, it would seem to put all basic-rate taxpayers in a better position. Currently, a basic-rate taxpayer contributing £100 net would receive £25 in tax relief to give a gross contribution of £125. Under the top-up system, you would need to be over 75 to get less than this – and, at the moment, entitlement to tax relief ends at age 75 anyway.
On the other hand, higher-rate taxpayers will be worse off if they’re over 34 years old – which the majority probably are. When the overriding message of recent years is that no one is saving enough for retirement, it seems contradictory to lower the incentives for this many people.
Speaking of lower incentives, the proposed way to fund this change is to cut the annual allowance to £20,000. For balance, I should say this could be an increase for high earners affected by this year’s tapered annual allowance – although if the top-up system came in reasonably quickly, their allowance wouldn’t have been that low for very long.
Nightmarish calculations
Additionally, those investors might be so thrilled to see the back of the nightmarish calculations that they don’t even mind the cut in tax relief. Joking aside though, that still leaves a huge group of investors who would see their allowance halved and their tax relief reduced at the same time. Can we really argue this is incentivising people to save?
I’ve heard claims that the top-ups would be simpler for people to understand than tax relief but I’m not sure this is entirely fair – both can be explained incredibly simply. If anything, the current system is easier to explain when you only want to provide a basic summary – you don’t pay income tax on money you put into a pension. It is explaining how it works in practice and outlining all the restrictions and considerations that causes confusion, and I’m reasonably sure the same would hold true under the top-up system.
For a start, I haven’t seen any suggestions for how or when the top-up would be claimed – this alone could become horribly complicated. For many, the top-up system will create a significant disparity between employer and personal contributions, so those who can negotiate with their employer to receive funding for personal contributions instead of employer contributions will be at an advantage. This also doesn’t seem to sit too neatly alongside auto-enrolment.
The biggest complication I can foresee, however, is the annual allowance, which is currently based on the gross value of an individual’s contributions. With top-ups, the same net contributions will produce a different gross amount every year – and for most people this change won’t coincide with the end of the tax year.
Those wanting to use the full annual allowance could find themselves needing to monitor their net contributions on an almost constant basis. This is at least as complicated as anything under the existing system. I suppose part of the proposal could be to base the annual allowance on the net value of contributions rather than gross, but there’s probably a raft of unforeseen consequences for that approach too.
Perhaps I’m being prematurely negative – after the past few years, I’m automatically nervous of further major changes. But if there’s one thing most parties seem to agree on, it’s the need for a simple, sustainable and understandable system to incentivise people to save for retirement. Perhaps this could be it. I just don’t envy the person responsible for ironing out the details.
Jessica List is pensions technical analyst at Suffolk Life
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