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Chancellor hints at cuts to pension tax breaks

Paloma Kubiak
Written By:
Paloma Kubiak

The Chancellor of the Exchequer today hinted of curbs to pension tax breaks ahead of the 2018 Budget just two weeks away.

Speaking at the IMF annual meeting in Bali, Philip Hammond said there are set to be cuts to ‘eye-wateringly expensive’ pension tax breaks’ as he seeks to balance the budget.

But the comment comes on the same day as the government published its response to the Treasury Committee’s report into household finances, which also covers pension taxation.

The Treasury Committee suggested the government may want to reassess whether there should be fundamental reform of pension tax relief, and give serious consideration to replacing the Lifetime Allowance with a lower Annual Allowance, as well as introducing a flat rate of relief.

As part of the government’s response published today, it stated that an earlier consultation showed there wasn’t a consensus for reforming pensions tax relief.

It noted: “The government is aware that any changes to the pensions tax relief regime could have significant impacts for pension schemes, employers and individuals. While the government keeps all taxes under review, no consensus for either incremental or more radical reform of pensions tax relief has emerged since the consultation in 2015.”

It did however mention that the Annual Allowance for higher earners (£150,000+ a year) has been restricted since April 2016 and the Lifetime Allowance has been cut from £1.25m to £1.03m as of April 2018.

“These changes allow savers to continue to make significant pension savings tax-free, while ensuring sustainability of public funds, and that incentives to save are targeted across society,” it stated.

Contradicting comments: what should we believe?

Kate Smith, head of pensions at Aegon said it seems inevitable that changes to pension tax relief are to come in the future.

“Pensions have been seen as ‘low hanging fruit’ by the government. We are not expecting to see any radical changes to the pension tax framework in this Budget due to the combined complications of implementing these for Defined Benefit schemes and the Brexit effect.

“If the Chancellor does follow through, the likelihood is that he will target the Annual Allowance rather than the Lifetime Allowance, which is easier to change and likely to bring in a steady flow of tax revenue.”

Tom McPhail, head of policy at Hargreaves Lansdown, said: “There are plenty of ways the Chancellor can raid our pensions to help balance his Budget. His ideal formula would be something which is easy to implement, doesn’t upset many people, raises lots of money and doesn’t seriously erode the long-term retirement savings system.”

McPhail lists the following five scenarios:

  • Reduce the Annual Allowance for all pension savers

Easy to do but would mostly affect higher earners. If it was cut from £40,000 to £35,000 many would see this as a bullet dodged. But if it were cut to £20,000, he’d upset an awful lot of people.

  • Reduce the Tapered Annual Allowance threshold

This is targeted at higher earners – those with incomes over £150,000. The Chancellor could cut this to perhaps £125,000 and there’d be little sympathy for the hundreds of thousands affected by it.

Or the taper could be applied more aggressively; currently the Annual Allowance is removed at a rate of £1 of allowance for every £2 earned, meaning it’s reduced to a minimum of £10,000 once someone’s income exceeds £210,000. This could be tweaked so it applies at a rate of £2 lost for every £3 earned.

  • Final salary scheme calculations

Defined Benefit pension scheme members receive more generous pension limits than those available to members of Money Purchase pension schemes.

For example, the test against the Lifetime Allowance is based on a calculation of 20:1, meaning a final salary pension of £10,000 a year is deemed to be worth £200,000 for the purpose of testing whether the member has exceeded the Lifetime Allowance.

But someone with £200,000 in a Money Purchase pension scheme who wanted to draw a guaranteed inflation-linked income (similar to a final salary scheme), could expect to receive an income of around £6,500 a year.

Any change to the rules would be practical to implement.

  • Scrap higher rate tax relief or move to a flat rate of relief

The only arguments in favour of this radical solution are that it could raise quite a lot of money, and many agree the present system of paying the most tax relief to the highest earners “looks a bit wrong”.

  • Reduce or scrap the tax free lump sum allowance

The tax free lump sum, usually 25% of accumulated pension savings, makes no sense but everyone loves it. Many people will be relying on it for existing spending plans or to pay off their mortgage, so any curtailment would have to be introduced slowly and progressively. This means it couldn’t raise much money in the short-term.