The Budget: what changes can we expect to pensions?
We’ll soon find out the outcome of the pension tax review which will have to save the government money, incentivise everyone to make adequate provisions for retirement and make the system less complicated.
Below is a summary of the anticipated possible changes, with those at the top of the list being the more probable reforms:
Top-ups enjoyed by higher earners reduced: It’s inconceivable that there won’t be some further restriction to the overall rate of top-up enjoyed by higher earner on their retirement savings. However this could be accompanied by a more generous top-up for low levels of contribution.
Restrictions on last minute tax relief: Assuming restrictions are placed on tax relief, HMRC is almost inevitably going to introduce same-say measures to prevent a ‘last hurrah’ for higher earners.
Employers have more work to do: Any changes to tax relief will have a knock-on effect for payroll, HR and finance department which could take up to two years to work through the system.
Salary sacrifice is abolished, taxed or curtailed: Around 71% of employers allow employees to give up pay in exchange for tax-efficient employer pension contributions and this is costing the government huge sums of money. Any reform could be accompanied by a move to restrict or negate benefits of salary sacrifice.
Annual allowance reduced: It’s currently £40,000 which to ordinary people looks like an annual salary rather than a pension contribution, but for higher earners, this is painfully low as a few years ago they could put in £255,000. A reduction would increase the need for a ‘carry forward’ option to allow older savers who’ve neglected their retirement saving a means to catch up.
Defined Benefit (DB) vs Defined Contribution (DC): Pension simplification is reversed so each are given their own regimes. The two scheme are fundamentally different and should be treated as such. This ‘carve out’ would make it easier for the government to reform DC pensions. It would also enable some of the inequalities between defined benefit and defined contributions to be ironed out.
Annual Allowance taper abolished: Employers hate this because of the administration and the Treasury knows this. But the taper was brought in to restrict tax reliefs for higher earners and the tax revenue it generates is already factored into their calculations. It is only going to be abolished as part of a wider reform of the up-front tax relief and Annual Allowance.
Tax relief abolished in favour of flat-rate top-up scheme: If you’re going to replace tax relief, this looks to us like the most sensible option. Most of the debate has revolved around a rate of between 25% and 33%. This approach would be more egalitarian than the current tax relief system, it would also satisfy the simplicity test.
Lifetime Allowance abolished: The LTA is widely disliked and is seen as a disincentive to save. It made some sense when the Annual Allowance was set at £250,000 a year; now it is a perverse irrelevance. The problem is the Treasury likes it and is reluctant to give it up.
Tax relief abolished in favour of tiered top-up system: This makes sense if the treasury wants to target the government’s top-ups to favour the lower earners, however it would potentially be more complicated to explain.
Employers lose relief on National Insurance contributions: This is potentially an attractive revenue raising measure – worth up to £14bn a year, however the Treasury does still rely on employer support for the pension system to work and this may be a step too far.
Tax relief is abolished and pension withdrawals are tax free: A pension ISA makes no sense as it would shift the fiscal burden to younger generation, could mean a re-write of auto-enrolment schemes, would remove any remaining brake on pension withdrawals and people are quite right to be sceptical about a promise for tomorrow being honoured.
Tax free lump sum retrospectively abolished: This would deny those who have yet to draw their pension the opportunity to take 25% tax free. It would destroy confidence in pensions and would be political suicide.
No changes to the pension system: This is not going to happen: the Chancellor is not going to pass up this opportunity for a bit of a tax raid and the pension system is so riddled with anomalies and inconsistencies that no reform at all would be a huge waste of eight months of analysis and consultation.