I have lost count of the many times that I have started a blog post by explaining that the forthcoming changes to pensions will be the most radical we have seen for many years but if the 16th March 2016 Budget is as I expect it will be, in this case there is no hyperbole.
The consultation paper “Strengthening the incentive to save” made proposals in the loosest possible sense and invited feedback from professionals on how they would like pension tax relief to be treated in the future. As detailed in this blog already the paper is more about unaffordable pension tax relief, particularly for higher rate tax payers, than it is about incentivising saving. I therefore expect to see pension tax relief being restricted and not much about making the system fairer or encouraging savings.
Notwithstanding this, it has been my opinion (and this was supported by an article in the Financial Times at the weekend) that pensions tax relief is likely to be moved to a flat rate model, for example by granting a total tax relief rate of 30% which could be funded in a similar way to relief at source.
The additional advantage of changing pension relief in this way is that if all pension contributions had to be paid out of net pay, and employer contributions had to be taxed in a very similar way to income, it would remove the incentive that is currently granted for salary exchange.
Salary exchange sees most employed individuals whose employers are offering such a scheme having their pension benefits augmented by up to a further 13.8%. When personal national insurance and income tax relief is taken into account total pension contributions increase under current rules can be by 36% – 76%, compared with the net pay equivalent, depending on an employee’s current tax rates.
The alternative system suggested in the paper would be to treat pensions more like ISAs so that they were taxed on the way in, exempt on the way out and exempt as they grow in the interim period. The problem with this system is it is extremely difficult to apply to those who are in occupational schemes, particularly final salary schemes which are funded by employers and also civil service schemes. Due to this complication a flat rate of pension tax relief could still reduce the level of tax relief granted by Treasury and could lead to significant tax bills for those who are accruing final salary benefits.
In terms of actions that you should think about taking, it is likely that implementing such a significant change will take some time, but contributions made before 16th March 2016 currently attract personal income tax relief at the highest possible rate which can vary between 20%-45% on an individual, more if done through salary exchange as detailed above.
For higher and additional rate tax payers particularly, I think there could be a benefit in making additional contributions, where affordable. In some cases this could be as much as £180,000 in the current tax year, if salary justifies this level.
Many additional rate tax payers will have an additional disadvantage applied to them as from the 6th April 2016 they will see their maximum allowable contributions reduce to £10,000.
The interference of these rules with the lifetime allowance makes the changes even more pertinent. Those who have significant funds, typically above £500,000, should consider seeking advice on whether contributions make sense post 6th April 2016. This is a speciality of our firm and we would be happy to discuss with you in more detail.