Expect further cuts to pension annual allowance, say experts
Prudential said the scope of the annual pension tax relief will likely be reduced as more and more people enter the system through auto-enrolment, effectively creating a tax gap.
The freezing of income tax thresholds will further contribute to the tax gap as new higher-rate tax payers continue to make use of exemptions when making contributions, it added.
This means that HM Revenue & Customs (HMRC) will likely be looking at reducing the impact of the relief scheme on its coffers, with lowering the annual tax-free allowance being the easiest option, the insurer suggested.
Head of business development Vince Smith-Hughes said: “There is only a certain budget available for tax relief. Currently the concern is that a lot of the budget is being used up by people who are receiving higher rate relief but people coming into auto-enrolment will obviously be using up quite a lot of the budget as well.
“There is a lot of talk about restricting the tax relief or restricting the tax free cash. Anything like that is going to be quite difficult.
“The more likely scenario is that [HMRC] will actually come to reduce the annual allowance further in the future. It’s going down to £40,000 next year but I think there is a possibility that we’ll actually see it being reduced further from that point.”
Savers would be well-advised to increase their pension contributions, where possible, while the current system is still in place, Smith-Hughes added.
He said: “If you’ve got clients who are able to pay higher levels of contribution now, why wouldn’t you do it now while it’s available?”
Smith-Hughes also pointed out that HMRC rules about the £100,000 income limit for personal allowance meant that savers would benefit from putting more money into their pensions one they crossed that threshold.
“People earning more than £100,000 lose their personal allowance gradually, so if they get to twice their personal allowance level (in addition to their income) they’ve lost all their personal allowance, that’s equivalent to [paying] a 60% tax rate.
“If you pay a pension contribution equivalent to that rate you’re effectively getting 60% tax relief and you actually got all of that tax back.”