Pension tax relief: all change?

Written by: Maike Currie, associate investment director, Fidelity Personal Investing
If you’re in a defined benefit pension plan, you belong to a hallowed group, generally referred to as the ‘lucky few’. These are called gold-plated pensions for good reason – your pension payment is ‘pre-determined’ based on your years of service and earnings and your company manages the pension assets.

Unlike a defined contribution pension plan, which the majority of us will hold today, your pension income does not depend on how much you contribute or the investment performance of your pension pot. It is considered a ‘Rolls-Royce’ pension paying guaranteed, inflation-proofed income, and not one to give up lightly.

Now here’s my question: will tax relief on pension contributions soon be thought of in the same way? As a very generous offering for the ‘lucky few’ who happened to be at the right place and time?

Will we be looking back in nostalgia at pension tax relief as a very generous incentive but, much like defined benefit pensions schemes, a thing of the past?

With the headlines saying the government is considering removing tax relief for higher earners altogether, it’s a very real possibility.

In the Summer Budget the Chancellor confirmed plans to cut pension tax relief for the top earners.

Under the proposals, due to be implemented on 6 April 2016, anyone with an annual income of more than £150,000 (including the value of their pension) will see the maximum they can pay into a pension whittled down from £40,000 to £10,000.

This means for every £2 of income you earn over £150,000, your annual allowance will be reduced by £1 until it has fallen to £10,000 for those earning £210,000 or more.

But even people with incomes of £110,000 could get caught out by the taper if pension contributions, including their own and those paid by employers, push them over the limit.

Now the government is proposing scrapping higher rate tax relief altogether as part of its review of pensions. Also under consideration is the introduction of a flat rate of tax relief and the possibility of up-front tax incentives for pension saving which is likely to pave the way for a unified savings regime that combines the best of ISAs and pensions in one flexible allowance.

The challenges with such a dramatic overhaul of the pensions landscape (once again) are manifold. As a start it will be complex and time consuming to implement – former pensions minister Steve Webb called the changes to top-end tax relief ‘bonkers’, it risks undermining the simplicity and popularity of the current savings regime, specifically the ISA while some argue that constantly tinkering with the pensions landscape will only serve to increase the public’s cynicism. By far the biggest risk is that these changes discourages and dis-incentivises pension saving.

If higher rate tax relief is completely abolished, it will be tricky to keep higher earners engaged with pensions – already the way this group saves for retirement is changing with many instead choosing cash benefits rather than saving into a pension.

Moreover, disenfranchising senior decision makers within companies is unlikely to encourage businesses to value pensions as part of their overall benefits systems.

The review of the pension’s landscape is expected to conclude in October, giving Chancellor George Osborne enough time to mull over announcing further pension reforms in the Autumn Statement, which usually takes place in early December.

Until then the most prudent thing private investors can do is to make the most of pension tax relief while it’s still around.

The amount you can save into a pension has effectively been ‘re-set’ for the current tax year from 9 July, meaning the tax year has been split into two notional periods – 6 April 2015 to 8 July 2015 and 9 July 2015 to 5 April 2016. In each period you can contribute £40,000 into your pension – £80,000 in total.

If you have the spare money to contribute, this wrinkle in the Budget small print makes the 2015/2016 tax year a key year for boosting your pension pot and making the most of pension tax relief before it becomes a thing of nostalgia.

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