After months of speculation the government has finally announced a plan to cut the cost of pension tax relief, currently coming in at around £20bn a year. Alistair Darling had a go last year with a scheme that involved tapered tax relief, but which almost no one actually understood. It’s good news, then, that George Osborne has now stepped in with a new, and far simpler, system that should, he says, save around £4bn a year.
Under the new rules the total amount of money you can put into a pension has been reduced. From April 2011 it comes down from £255,000 a year to £50,000. The government will then give you tax relief on it at your marginal rate (20%, 40%, or 50%). That marks a big drop in possible contributions levels, but it isn’t one that is going to bother the vast majority of the population much: £50,000 is more than most people ever pay into a pension. Note that the average total pension is around £30,000, something that means that the new shift in the lifetime allowance from £1.8m to £1.5m won’t affect too many people either.
The other good news is that Osborne has entirely abandoned Darling’s plan to taper tax relief. From next April, taxpayers will continue to receive tax relief on their pension contributions equivalent to their highest rate of income tax. So whatever you pay into your pension will have 20% added to it by the government, and higher rate taxpayers can claim back the further 20-30% tax relief due through their tax return. Just be aware that the new annual allowance is the gross amount, so you can’t put £50,000 into your pension and then expect the government to put in another 20% – the £50,000 limit includes tax relief.
However, if you are one of those who might want to put in more than £50,000 in one year, if not in others – perhaps because your income is ‘lumpy’ – don’t panic. Under the new rules you can roll up any unused allowance in the previous three years and use it all at once. So if you pay £20,000 into your pension one year and £10,000 the next year, you could pay £120,000 in the next year.
This concession will also ease the pain for those in final-salary schemes. Your contribution is now worked out as the increase in your annual pension benefits multiplied by 16. The calculation is based on the difference in your pension benefits at the beginning of the year and the end. So without the three-year rule a large pay rise (which, in final-salary land, means a large one-off rise in the value of your pension) could have pushed many over the annual limit. But with the three-year rule this problem largely disappears.
Remember that pensions aren’t your only tax-efficient option. The annual Isa limit hasn’t been cut, so the £10,200 you can invest will remain free from capital gains tax. That rises to £10,680 for the next tax year.