Chancellor George Osborne has already made a raft of bold changes to Britain’s pension system. But he’s not done yet. It looks like he’ll be targeting tax relief on pension contributions in the next budget – and for many, these changes won’t be anywhere near as welcome as the “pensions freedom” revolution. Today, pension tax relief is paid at the same rate as your marginal rate of income tax.
So basic-rate taxpayers receive 20% tax relief (every 80p they stick in a pension is topped up to £1 by the tax office); higher-rate taxpayers receive 40%; and additional-rate taxpayers 45%. In total, this tax relief costs the state £21.2bn in 2013/2014. And roughly 71% of this total – £15.1bn – went to higher and additional rate taxpayers, notes the Pensions Policy Institute (PPI).
Now that’s a very tempting sum of money for a government still struggling to bring down a hefty deficit, and what with the Conservatives burnishing their image as the “true workers’ party”, reform also offers a valuable opportunity to suggest that they’re on the side of lower-income voters. So speculation is now rife that the existing regime will be replaced by a flat-rate government contribution. Everyone will get tax relief at a single flat rate – likely to be between 25% and 33% – regardless of income. The PPI estimates that a flat rate set at 25% would save £6.1bn a year, and a 30% rate £1.2bn. Thus “it would satisfy both political and fiscal imperatives for the chancellor”, says the Financial Times.
However, clearly this isn’t so great for higher-rate taxpayers. If confirmed in the budget in March, the new rules will render pensions far less attractive to higher-rate taxpayers, particularly those who are likely to remain higher-rate payers when they come to retire. It will certainly make Isas (individual savings accounts), where money is taxed on the way in, but completely tax free on the way out, the first tax shelter of choice for anyone paying 40% or 45% income tax. The obvious advice is to take advantage of existing pension tax relief as quickly as you can.
The FT reckons that any changes will take at least 12 months to implement, rather than happening overnight as some commentators suggest, which seems likely, given the complexities involved – not to mention the likely objections from the asset management industry, which stands to lose out heavily as wealthy investors forsake pensions. But even so, if you haven’t already maxed out your contributions this year (the annual limit is £40,000; you can’t contribute more than you earn in a given year; you can carry forward unused allowances from the previous three years), it’s worth looking to see how much you can sock away.