Pensions: the BACKLASH
The Chancellor faces calls this week to reverse a planned tax grab. Follow our guide to what it will mean for you
EARLIER this year George Osborne revolutionised pensions by allowing savers to seize control of their funds. But this dramatic transformation of the pensions landscape is not without its critics – or financial pain.
The over-55s may now be enjoying the new pension freedom regime – even spending their savings on cruises and Lamborghinis. But those still building a retirement fund face swingeing restrictions on how much they can put aside as a result of cuts to savings allowances scheduled for next April.
With pressure mounting on Osborne – ahead of Wednesday’s Autumn Statement – to delay them, The Mail on Sunday examines the key pension changes and looks at ways savers can soften their impact.
ANNUAL ALLOWANCE
THE RULES
YOU can currently save a maximum £40,000 per tax year into a pension and enjoy tax relief on your contributions at your highest marginal rate of tax.
The £40,000 contribution cap applies to both personal payments into a pension plus any made on your behalf by an employer through a works pension.
The contribution cap for final salary schemes is calculated in a slightly different way, using a multiple of the increase in pension benefits accrued in the tax year.
As it stands, the system benefits higher rate and additional rate taxpayers the most because they enjoy respective tax relief of 40 and 45 per cent on their contributions.
So, a £10,000 contribution costs a higher rate taxpayer £6,000 while an additional rate taxpayer pays just £5,500. Basic rate taxpayers get 20 per cent tax relief, meaning £10,000 of contribution costs them £8,000.
But the Government says the cost of providing tax relief on pension contributions – £50billion a year – is unsustainable.
It has launched a review into how costs can be reined in and although we will not find out the outcome until next year’s spring Budget, it is likely that tax relief for high earners will be curbed. Ahead of this, Osborne has already sought to chip away at costs. One of these cost-cutting measures is a reduction in the annual contribution allowance for additional rate taxpayers.
WHAT IS HAPPENING
FROM the start of the new tax year on April 6, those earning more than £150,000 will see their ability to fund a pension – without incurring swingeing tax charges – seriously curtailed.
For every £2 of income above £150,000, they will see their permitted annual contribution – including employer contributions – fall by £1, down to a floor of £10,000. So, for those earning £210,000 and above, their annual allowance will be set in stone at £10,000.
The income that is taken into account in calculating your reduced annual contribution allowance – socalled ‘adjusted income’ – includes dividends, savings interest and the contributions an employer ploughs into your pension.
So, for example, someone earning £200,000 a year and paying six per cent of salary into their company pension contributes £12,000 a year.
They enjoy 45 per cent tax relief on this, meaning the contributions cost them £6,600. If an employer pays in 10 per cent on top, this results in a further £20,000 going into their pension.
Under the new regime, this additional rate taxpayer’s ‘adjusted income’ is £220,000 – £200,000 plus £20,000 of employer pension contribution (we are assuming they have no other earnings, dividends or interest on savings). This means their maximum annual allowance is reduced from £40,000 to £10,000. Doing nothing would result in a tax charge of 45 per cent, applied to the excess of contributions (£22,000) over the tapered allowance of £10,000. In other words, a tax bill of £9,900.
WHAT THE EXPERTS SAY
PENSION experts believe the introduction of this tapered annual allowance should be postponed until the Government has come up with its recommendations for reform of tax relief on contributions.
Gareth James, head of technical resources at pension provider AJ Bell, says: ‘It’s just not sensible for the Government to be going ahead with this reduction in the annual allowance. It could come in just as an overhaul of tax relief is announced, a process that would make the need for tapering of the allowance redundant. Postpone it rather than make a complex pensions system even more bewildering.’
Investment manager Fidelity International agrees. Richard Parkin, head of retirement, says the reduction will not just impact on City ‘fat cats’ but ‘hard-working business people and professional public servants such as General Practitioners and surgeons’.
He also believes the proposed restriction is unfair on employers. He says: ‘It is not reasonable to expect companies to stay committed to operating good quality pension schemes if they are forced to endure and pay for constant change.’
WHAT YOU CAN DO
FINANCIAL planner Patrick Connolly, of national independent adviser Chase de Vere, says there are ways high earners can mitigate the adverse impact of the impending reduction in their annual pension contribution allowance. He says: ‘First and foremost, those affected should look to maximise pension contributions on which they can benefit from initial tax relief (£40,000) before April 2016. Furthermore, the transitional rules govern-
ing the introduction of the tapered annual allowance will provide some high earners with an £80,000 annual allowance in this tax year.’
This will result, he says, from the requirement for company pension schemes to align their pension contributions year with the tax year. Some high earners will also be able to boost annual contributions this year by sweeping up any allowance they failed to use in the previous three tax years. This process is known as ‘carry forward’.
Gary Smith, a financial planner at Tilney Bestinvest, explains: ‘To carry forward any unused annual allowance, an individual must first use their maximum annual allowance for the current tax year. But it’s a tactic well worth considering given the annual allowance in the tax year ending April 5, 2013 was higher at £50,000.’
He also says that high earners should continue to use these carry forward allowances after April next year. He adds: ‘Even if an individual incurs a tapered annual allowance, they will still be able to carry forward unused allowances from previous tax years. These will not be affected by the taper and will be based upon the annual contribution applying at the time in each specific tax year.’
Connolly says high earners should also consider investments other than pensions – including tax-friendly Isas, venture capital trusts (VCTs) and enterprise investment schemes (EISs). ‘The change to the annual allowance opens up a minefield,’ he adds. ‘Independent financial advice could prove invaluable.’
LIFETIME ALLOWANCE
THE RULES
CURRENTLY, the Government allows you to build a pension fund worth £1.25million. This is known as the lifetime allowance.
From age 55, you can then access it with a quarter of the fund – in most instances – being tax-free. Any withdrawals above this tax-free amount – taken either as regular income through the purchase of an annuity or as a lump sum – are subject to tax at your highest marginal rate of tax.
But if your pension exceeds £1.25million, the Government will want a slice before you can get your hands on it. Any surplus above £1.25million will be taxed at either 55 per cent (if taken as a lump sum) or 25 per cent if taken as part of a regular income. The income will also be subject to income tax – in effect double taxation.
For those who have the right to a defined benefit pension, they can assess whether they have possible lifetime allowance tax charges by multiplying the income they are likely to get at retirement by 20 and then adding on top any tax-free cash entitlement.
If this calculation results in a sum above £1.25million, they will face a lifetime allowance tax charge.
WHAT IS HAPPENING
FROM April 6, the lifetime allowance falls to £1million. To put this into perspective, the allowance stood at £1.5million when first introduced in 2006 and rose to £1.8million in 2010. Since then, it has steadily eroded.
WHAT THE EXPERTS SAY
ALTHOUGH a £1million fund may seem a lot, it is not. Far from it. Steven Cameron, director of insurance company Aegon UK, says: ‘Though £1mil- lion may appear a huge sum, it only buys someone an annual retirement income of about £25,000. That is hardly a fat-cat income.’
The numbers are different for those with defined benefit pension funds. Tilney Bestinvest’s Smith says the lifetime allowance reduction is only likely to be an issue once someone has built annual pension entitlement of around £43,500.
Cameron says the cut should be reversed by the Government pending the outcome of the wider review of pensions tax being conducted by Osborne and his Treasury team.
He also says constant reductions in the lifetime allowance send out the wrong message to savers. He adds: ‘Although this reduction may appear to be aimed at higher earners, it lets all savers know that the pension rules can be turned against them whenever the Government sees fit.’
Malcolm McLean, of pension consultant Barnett Waddingham, says: ‘The reduction in the lifetime allowance is a retrograde step. It penalises good pension fund performance and it’s yet another complication in an already complex pensions world.’
WHAT YOU CAN DO
INVESTORS worried about exceeding the lifetime allowance can apply
for so-called ‘protection’, but this comes with strings attached.
Under ‘fixed protection’ they will retain the current £1.25million lifetime allowance but only on condition they (and their employer) make no further contributions to their pension fund.
‘Individual’ protection allows a person to retain a lifetime allowance equivalent to the value of their pension benefits on April 5, 2016, subject to a minimum £1million and a maximum of £1.25million.
Claire Walsh, a chartered financial planner with Aspect 8 in Brighton, East Sussex, says: ‘Anyone who thinks they might have a lifetime allowance problem should seek independent financial advice.’
Walsh, who is also a spokesperson for find-an-adviser website unbiased, believes the lifetime allowance should be scrapped. ‘It’s complex, penalises savers and disincentivises people from putting money into pensions,’ she adds.
Chase de Vere’s Connolly says savers impacted by the lifetime reduction should also consider investment alternatives such as Isas, VCTs and the EIS – the same vehicles that those hit by the tapered annual allowance should look at. Tilney Bestinvest’s Smith says some savers may be happy to accrue benefits above the lifetime allowance. ‘After all, 45 per cent of something is better than
100 per cent of nothing,’ he adds.
TAX RELIEF
THE RULES
PEOPLE are encouraged to save into pensions through being offered tax relief on their contributions. The rate of relief is dependent upon a taxpayer’s highest marginal rate of tax.
So a basic rate taxpayer gets 20 per cent relief while higher rate and additional rate taxpayers receive 40 and 45 per cent relief respectively. Nontaxpayers get 20 per cent tax relief.
WHAT IS HAPPENING
THE Government is reviewing how people should be incentivised to save into pensions. This will invariably result in changes to tax relief available on contributions.
All options are being considered. They include everything from doing away with tax relief altogether, through to the introduction of a flat rate of relief – 30 per cent, for example. Osborne has said he will reveal his hand in next spring’s Budget. But he may tell us more on Wednesday.
WHAT THE EXPERTS SAY
MOST experts believe a flat rate of tax relief would be the fairest outcome of the current review into pension saving incentives.
A survey published last week by Aegon UK showed strong support for a flat rate Government incentive of 30 per cent. Indeed, 59 per cent of those surveyed said they would save more if a universal 30 per cent rate of relief on contributions was introduced.
Support for Isa-like pensions – where contributions are funded out of net income while all proceeds are taken tax-free – seems to be diminishing although such a radical change cannot be ruled out. It would give the Government a multi-billion pound saving.
WHAT YOU CAN DO
HIGHER rate and additional rate taxpayers should maximise their pension contributions while they can – provided they keep an eye on lifetime allowance issues.
‘Saving into pensions is not going to get more attractive,’ warns Walsh. ‘So save what you can, while you can.’