One for all?
The Chancellor puts high earners on guard for a single rate of pension tax relief.
George Osborne’s first ever Conservative majority Budget in July 2015 delivered some surprising economic and social reform. Introduction of a National Living Wage rate that will rise to £9 an hour by 2020, increases in dividend tax, and changes to Corporation Tax could all have been rooted in left-wing politics; they’re not the sort of reforms that typically resonate with traditional Conservative voters.
Clearly, Mr Osborne has shown he is not averse to making some swashbuckling reforms, especially when it steals a march on the Opposition.
In the spring of 2015, he gave individuals over the age of 55 the right to seize control of their pension, prompting the famous suggestion that savers could use it to buy a Lamborghini. At the same time he loosened restrictions on inheriting pensions. Furthermore, he has been gradually reducing the amount that wealthier savers can put into their pension tax-free.
But with another Budget scheduled for 16 March 2016, should pension savers brace themselves for continued revolution?
“Absolutely,” says Steve Moy, wealth management consultant at St. James’s Place. “We are expecting a big announcement on pension tax relief.”
It has been over a decade since the government last reviewed the support on offer through the tax system for those saving into a pension; and at a time when the Chancellor needs to make deeper cuts in spending, pension tax relief seems like an increasingly obvious target.
At the moment, pension contributions attract tax relief at 20%, 40% or 45%, depending on an individual’s highest rate of Income Tax. Consequently, over two thirds of tax relief goes to higher and additional rate taxpayers1. Under one third goes to basic rate taxpayers, who arguably need the greatest incentive to save if they are not to fall back on the state for support.
The Chancellor has made it clear that he wants to tilt the system towards those who need the most help, whilst cutting back on the £35 billion paid in tax relief each year1. The consultation, which sought feedback on ways to achieve this, has now closed and the Chancellor is expected to use the Budget in March to respond to the findings.
“Reform needs to be done in a way that helps reduce the deficit, so I expect any new system to look significantly less attractive to those who can most afford a cut,” says Moy.
All for one?
Rather than put forward a specific proposal for reform, the government approached the consultation with an open mind, seeking input from industry and the public. But experts think it very unlikely that some of the more radical ideas initially suggested, such as the ‘pension ISA’, will see the light of day.
It is thought that the Chancellor is convinced that maintaining the current system of upfront tax relief is the most effective method of achieving his aims. But crucially, he could be about to break the link between income and pension tax relief by introducing one flat rate instead of the tiered system of today.
This flat rate could be anywhere between 20% and 33%, depending on how much the government is looking to save. A flat rate of 25% could save the government billions and represent a modest incentive to basic rate taxpayers; but it risks disenfranchising high earners who would be much worse off. A flat rate of 33% would throw something akin to an olive branch to higher earners, but it would be fiscally neutral.
“Results of the consultation are expected to be announced on 16 March 2016. This should give us more details of the rate and a timetable for its implementation,” says Moy.
But if some reports are true, the new rate could be in place immediately. Slamming the door shut on higher rate tax relief could bring instant savings for the government. Leaving the door ajar would only serve to encourage a surge in tax-relievable pension contributions from wealthier investors, which would offset the government’s tax saving.
“Osborne could stand up in the Commons and say that contributions from 16 March 2016 will no longer attract tax relief at the higher rates,” warns Moy. “Higher earners looking to make contributions sometime after the Budget could therefore end up rueing a lost opportunity.”
Consequently, some higher earners are scurrying to bring forward planned pension contributions to before the Budget. Under ‘carry forward’ rules, it is possible to make pensions contributions of up to £180,000 this tax year by using unused allowance from the three previous years, and benefit from rates of tax relief at 40% or 45% in the process, assuming that anything over the basic rate of tax relief was reclaimable via the individual's tax return.
“Tax relief at the higher rates could be consigned to the history books, so higher earners should consider acting now to make the most of current rates before an expected announcement in the Budget,” says Moy.
With increased longevity and the changing nature of pension provision, the government needs to ensure that the system incentivises more people to take responsibility for their pension saving so that they are able to meet their aspirations in retirement.
But make no mistake, these reforms are as much about easing the public purse as they are about strengthening the incentive to save. In the context of the deficit and the continuing pressure on public finances, it will be no surprise if the government puts higher rates of tax relief to the sword on Budget day.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances. The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
1 Strengthening the incentive to save: a consultation on pensions tax relief - HM Treasury, July 2015