It would be irresponsible to encourage pensions savers to take any radical action such as putting a large lump sum into their pots, or worse, cashing it all in, because of speculation about pensions tax rule changes in this week’s Budget.
However, there is no doubt that has been a period of frenzied accumulation activity going on over the last three months right up until George Osborne ended tax reform speculation, making it clear that he was not going to abolish higher rate pensions tax relief or move to an ISA-style pension regime (just yet).
So much so that AJ Bell estimated last week that the Chancellor incurred a £1.5bn additional pension tax relief bill as savers poured billions of pounds into pensions over recent months in fear of reliefs being curtailed or abolished.
It is understandable that there was speculation that he would go down this route because he opened up such a wide-ranging three month consultation on pensions tax reform during last summer.
In addition, Michael Johnson at the Centre of Policy Studies has been conducting a very vocal and articulate campaign to encourage HM Treasury to adopt the so- called pension ISA idea with a taxed-exempt-exempt (TEE) regime for more than three years. TEE means that pension savings would be taxed on the way in, remain exempt at point of saving and when asset values rise, while making income withdrawals tax exempt for the first time.
There has been a strong feeling from right across the provider world that a move to pension ISA was a market reform too far in the wake of the pension freedom revolution which Osborne forced on the pensions market less than a year ago.
Number crunching
On the other hand, many say that the current pensions tax relief regime is regressive. It benefits higher rate taxpayers exponentially while modest earners miss out.
The numbers tell the story: 1% of top taxpayers receive 13% of all pensions tax relief which now amounts to a total of £35bn per year and rising. In fact, the top 1% get the same amount of tax relief as the bottom 50%.
Currently basic rate taxpayers make 50% of all contributions but only receive 30% tax relief. In contrast, higher rate taxpayers receive 50% of relief but make only 40% of contributions.
On the other hand, those getting higher tax relief on pension contribution are also paying more tax throughout their working lives so the tax relief on pension contributions is payback time, as wage inequality continues to grow, it seems wrong that any government should not look at ways of levelling the playing field just a little bit. So what potential reforms are still on the table for Osborne and what, if any, surprises are in store in a couple of days’ time?
We know the lifetime allowance (LTA) will definitely fall to £1m from 6 April and bearing in mind it has been progressively cut from a height of £1.8m just six years ago, you would expect to see LTA continue to be at the mercy of the Chancellor’s knife for some years to come.
The LTA reduction will hit middle to upper earners planning for comfortable retirements, as Aegon found: defined contribution (DC) policyholders with a £1m fund saved at retirement may only be able to garner an annual retirement income of about £25,000. While defined benefit (DB) policyholders do a good deal better as they are not likely to see a higher tax bill until they’ve built an annual pension entitlement of about £43,500.
Another threat lies in an attack on salary sacrifice, whereby savers give up part of their earnings in return for their company paying it into their pension. This benefits both workers, who get full tax and national insurance relief, and companies that save on NI.
However it is open to abuse and it is possible that salary sacrifice will be declared a form of tax avoidance and employers might be threatened with the government’s general anti-avoidance rule (GAAR) – meaning that if employers are found to be engaging in tax avoidance in this way they could be made to pay the missing NI for both employer and employee back.
That could see rapid unwinding of existing salary sacrifice schemes and no new ones being set up. This change would seem politically palatable and would return up to £1bn to the Treasury annually.
Lump sum
Another option is a restricting of tax-free cash allowance which presently stands at a very generous 25% of the value of the pension. This could be pegged back to a maximum tax-free cash payment of somewhere between £25,000-£100,000.
Depending on where this restriction falls it will be a serious blow to the wealthy but would not impact lower earners who generally amass retirement savings of less than £100,000 today.
This change could be phased in to avoid at-retirees being ‘cliff-edged’. It seems likely to happen as right now the over 55s are able to recycle tax-free cash from one pension in another, thereby extracting tax-free cash sums several times from several pensions. This works because, while income payments from pension plans are treated as taxable income, this income can be effectively offset by the tax relief given when the payment is re-invested into another pension plan.
This works because, while income payments from pension plans are treated as taxable income, this income can be effectively offset by the tax relief given when the payment is re-invested into another pension plan.
That said, the HM Revenue & Customs does not classify income from pension plans as relevant UK earnings, and therefore the member would need to have relevant UK earnings from another source so that they are eligible for tax relief on the re-invested payments. This round-tripping manoeuvre seems ripe for by targeted reform by the Chancellor this time around.
Off the table this time, but more likely than the pension ISA to be put back on the Treasury’s drawing board in the future, is setting of a flat rate of tax relief of between 25% and 33%, redistributing the top-up towards basic rate taxpayers and still savings billions for the Treasury.
If the Chancellor was to change his mind (when the political climate is more favourable), replacing rates of relief based on marginal rates with 25% applied on gross contributions, would generate much-needed billions in saving, equating to a 33% top-up to contributions paid from after tax income.
Former pensions minister, Steve Webb, has been a long-term backer of a flat rate as a great way of redistributing relief to low earners. The ABI is also advocating it.
So there is a good deal of potential change possible in this Budget but look out for just one or two tax avoidance ruses by wealthier pensioners to be in the firing line as Osborne seeks to ruffle less feathers in the pensions world (and on the Tory backbenches) than he has in the last few Budget announcements.
Adrian Boulding is retirement strategy director at Dunstan Thomas
The post Adrian Boulding: Pension tips for the 2016 Budget appeared first on Retirement Planner.