If I had known how much of my adult career would have involved worrying about other people’s pensions I think I might have chosen another path. These days everything seems to bring me back to the same subject.
We vote for Brexit. “Thank goodness”, I think. George Osborne will be off before he can think of any other silly ways to muck up the incentives in the pension system.
Trump gets in. “Phew”, I think. Finally bond yields are on the up — that’ll offer some respite for defined benefit pension schemes (their deficits shrink as bond yields rise).
The investment world starts to get panicky about inflation. “Wonderful”, I think. If we can get public debt down with a little financial repression we might be able to keep paying everyone a decent state pension.
The Autumn Statement is coming up. “Ooh… interesting”, I think. I wonder what Mr Hammond will do about higher-rate tax relief for pension contributions.
See what a handicap this is? Still, we are where we are. So let’s talk pensions for a bit. I wrote a few weeks ago about how no one ever stands up for the well-off when it comes to taxation any more: most people figure it makes sense for them to be the go-to group every time the state feels more strapped for cash than usual. Several people wrote in after this to say “if only”. The rich, they said, are far too mollycoddled. They haven’t suffered one bit from austerity. It’s not fair.
But that’s not strictly true. They have. They’ve lost their annual income tax allowance and their child benefit. They’ve seen their stamp duty bills soar. They pay more on dividend income, and the change in buy-to-let tax regulation will reduce their rental incomes. They’ve also seen a huge rise in their effective rates of income tax as a result of changes to their pension allowances.
None of these things are tax rises, you will say — they are all cuts in allowances. You are right. It is a totally different thing, in theory. But in practice it boils down to much the same thing.
Let’s say you have a pension that has hit the lifetime allowance. You earn £110,000 and have been putting in £30,000 a year. You can’t put any more in without having to pay 55% on it when you withdraw it from your fund later. So you don’t. That means that instead of paying tax and National Insurance on £70,000 of income you are paying it on £100,000. Your total tax bill goes up from £26,133 to £34,533, or an overall rate of 26.1% to one of 3%.
Let’s say you have a defined contribution pension (the type where you save the money and end up with a pot to do with as you like at age 55). You earn £250,000. Until the announcement of the new £40,000 limit you were paying £50,000 a year into your pension. You therefore paid tax and NI only on £200,000, a total of £83,433 (using this year’s rates to make the comparison simple). Under the taper you can now only put in £10,000. So on £240,000 you pay a total of £102,233. You haven’t earned a penny more. But what you see as your annual tax bill just went up £18,800 — and your overall rate from 33.3% to 40.9%.
If you have a defined contribution pension this isn’t the end of the world. There are still some chances to game the system: if you over-invest in a pension at a young age to get decades of tax-free growth; or if you are planning your pension to be an inheritance-tax avoidance device. And you can comfort yourself that you would have had to pay some income tax had you withdrawn the money from your pension at any point anyway.
On the other hand, if you have hit your limits, you do pay more tax on an annual basis and you do lose your chance to arbitrage your tax rates (getting relief at 45% as you put money in and paying 20% when you take it out later) and to use the 25% tax free lump sum you get from pensions on retirement.
Look at it like that — as many high earners do — and it is a stealth income tax rise, just a very complicated one. I haven’t looked at how HMRC insists you make your calculations on what your tapered allowance is here (even on its website the simple explanation takes ten bullet points) or how the taper affects defined benefit pensions (another time). But, trust me, the complications and possible effective tax rises in that really would blow your mind (or bore you to death).
Back to the Autumn Statement. I have high hopes for Mr Hammond. Both his predecessors had an eye to nabbing their bosses’ jobs at some point. As Hargreaves Lansdown’s Tom McPhail pointed out to me this week, that meant that they made too many of their decisions with more of an eye to crowdpleasing than to long-term success.
That’s why we have the taper and the lifetime allowance in the first place (a sop to the left). It’s why we have the ridiculousness of pensions being inheritance-tax free (a sop to the right). And it is why we have pension freedoms at all (a sop to everyone).
Hammond might be different. He isn’t obviously anywhere in line for Theresa May’s job. So he might, just might, have a go at sorting out some of the nonsense in our system. That would be wonderful. The downside is that, if he does, and the answer to the question “how’s your pension” becomes “fine, thanks”, I really would have nothing to talk about.
• This article was first published in the Financial Times