Pensions relief changes in the frame?

Posted by John Stokdyk PM | on Mon, 20/02/2012 - 13:32 1195 5 comments | report

Rumours have been circulating within the profession and around Westminster about the government’s plans to tinker with the pensions tax reforms in the March Budget. Liberal Democrat chief secretary to the Treasury Danny Alexander set the hare running in an interview with the Telegraph last week, which was followed up by a well informed blog by the Telegraph’s personal finance editor Ian Cowie. The Express also sounded the alarm this morning.

PwC’s pensions group turned up the volume a little this morning with a piece in Tax-News.com

That analyses the options being mooted for reducing tax relief on pensions saving.

Cutting relief on all contributions to the basic 20% rate is one option, but would result in higher rate taxpayers at the 40% threshold losing £20 for every £100 invested into a pension.

Those paying the 50% top rate of tax would lose £30 for every £100 invested. Pensions are taxable on receipt, meaning that there would be further tax to pay possibly at the 40% or 50% rate when the taxpayer retires.

There is also the potential for those contributing to defined benefit schemes finding themselves having to complete a tax return because the extra tax charge could not easily be deducted at the outset. According to PwC, depending on how the policy is formulated, the tax liability may need to be calculated by reference to the increase in pension benefits during the year and taxed as a benefit-in-kind.

“Should pensions tax relief be reduced to basic rate relief, higher and top rate tax payers may be better off if they were simply paid cash and taxed on it as income tax at the time,” commented Raj Mody, head of the pensions group at PwC.

Alex Henderson, tax partner at PwC, added: “There would be real practical problems with calculating and applying a restriction on tax relief for all 40 and 50% taxpayers in defined benefit schemes. People would essentially need to get used to seeing a charge for their pension as they would do for a company car or any other benefit.”

A second option the government is rumoured to have considered is a reduction in the annual allowance. At present, the annual allowance for tax efficient pension saving is currently £50,000, having been reduced from £255,000 in April, 2011.

PwC believes that capping the allowance further would be a simpler measure to implement and would still give everyone a strong incentive to put some money into a pension. On the other hand, depending what the allowance is reduced to, substantial numbers of middle income earners could be affected. In particular, those who have been in final salary schemes for some time could be hit, seeing benefit-in-kind charges if the increase in their pension pot exceeds the allowance in any year.

Comments

I don’t like the fact that 2 thanks

ringi | Mon, 20/02/2012 - 14:31 | Permalink

I don’t like the fact that someone can get 40% tax relief paying in, but then move to Cyprus when they retire and only pay 5% tax on the money they take out of the pension. So I would like to see all payments from a pension scheme that got UK tax relief to be chargeable to UK tax regardless of where the person is living in the world at the time the pension is taken.

An employers based scheme saves the N I payments, so get tax relief that is a lot more than a personal pension scheme. So a fairer and simple system may be just to add somethink like1/3 to all personal pension payments regardless of the person’s current tax rate, and not allow any additional tax refund for higher rate tax payers. (One less item for people to get wrong on their tax return!)

Analysis from John Endacott, Francis Clark

John Stokdyk | Thu, 23/02/2012 - 10:47 | Permalink

This is an analysis I found on a pre-Budget thoughts blog from John Endacott at Francis Clark. There's more to it if you follow the link:

"The idea of abolishing higher rate (40%) and additional rate (50%) tax relief is very difficult to see being implemented. Any change to the self-assessment tax system is very easy to deal with in terms of the self-employed or other employees that are within a money purchase pension scheme. The problem is how to deal with the defined benefit schemes and in particular, the final salary schemes within the public sector. The implications of abolishing higher rate tax relief work very badly for non-contributory pension schemes such as that operated in the civil service (the people that are likely to be deciding on any such policy) where large tax charges would arise every year on many employees who would have no funds from which to pay them because the monies would be within the pension scheme.

"Apart from this being a well known issue, Alistair Darling did try to attack the pension scheme tax relief in his final years as Chancellor and the Coalition had to unravel it because it was simply unworkable. The result was a system whereby there is an annual allowance of £50,000 and it was felt that at this level it was manageable to deal with any of the tax issues. Even then we are already seeing tax charges arising on members of final salary pension schemes in this context where the benefit exceeds the annual allowance.

"One possibility is that the government could reduce this £50,000 limit but it is difficult to see it coming down much. As far as most taxpayers are concerned outside the final salary schemes then a limit of £20,000 or £30,000 would be more than sufficient even before one starts to take into account the carried forward capability. The other thing is that it just looks inconsistent to drop the limit one year and then mess about with it another year and I think George Osborne will try to resist this. So it is possible, but my personal expectation is that the £50,000 limit will be here for a few years and will simply not be indexed upwards. The result will be that it will be eroded by inflation and will drag further employees into the tax net over time. I could be wrong but that seems the reasonable best guess at the moment.

"So what does that leave? Well, it leaves the tax free cash.

"The justification for the tax free cash originally was that because the pension fund had to be used to purchase an annuity that it was reasonable to give the pensioner a tax free cash lump sum up front to compensate for the risk of early death and to go some way to making the pension arrangement more attractive. However, two things have happened since then:-

Life expectancy has increased substantially; and
There is no longer any obligation to take an annuity.

"As a result, the tax free cash looks an anachronism and looks exposed. A further consideration is that there is a general public mood against fat cat payoffs and large tax free cash lump sums from pension schemes have tended to be part of this in the past.

"Possibilities include taxing the tax free cash lump sum, restricting the right to take a lump sum or a combination of the two. For my money, a monetary cap on the tax free cash lump sum looks the most likely."

Killing pension saving ....

JC | Thu, 23/02/2012 - 18:03 | Permalink

@ringi - matters are changing, although perhaps not going as far as you would wish

http://www.qrops.net/qrops-2012-pension-changes-explained/

Furthermore, as well as moving the goal posts from 5 to 10 years it looks as though it may also be retrospective

@John Stokdyk

The real nasty in all this is the suggestion that the tax free lump sum could be subject to tax above the 40% threshold. Whilst this may be the way forward for the future it would clearly be onerous & unfair on those retiring within the next few years because to all intents & purposes it would be retrospective

No government should change the rules after 30-40 years - pensioners have saved for x years in the expectation of receiving this lump sum and to change the rules at the last minute is clearly inequitable. Furthermore, if this did occur, I would not be surprised to see a raft of 'human rights' claims because clearly the state is unfairly penalising pensioners with last minute changes

What happens to all those on interest only mortgages who are relying on this lump sum to clear their mortgage?

By all means change the rules for the future but not after the event and make an orderly transition with proper rules.

Yes pension pots are regarded as fair game, especially when todays politicians are looking for stashes of 'free cash' but quite frankly these moves will make it unattractive for ordinary people to save for retirement - at which point everyone will just fall back on the state in future

Never forget that this government has just 'stuffed' the state pensions of women born aged around 57-58 by unfairly additionally penalising them with an extra year before being eligible to draw their pension

It would seem as though the government is intent on hurting those that cannot fend for themselves whilst letting real horror stories go scott free - mmm .....

Tax free cash

3point14 | Fri, 09/03/2012 - 14:51 | Permalink

John Stokdyk wrote:

...For my money, a monetary cap on the tax free cash lump sum looks the most likely."

A cap on this already exists as it is limited to 25% of a maximum pension fund of £1.5m (or £1.8m if preserved rights) which is £375,000.

In addition, a great many people are reliant upon this 25% to pay down part of their mortgages.

For those starting out, they have seen allowable pension contributions drop by over 80% (£255k to £50k), retirement dates pushed back 5 years (to age 55 from 50) and now they want to limit tax free cash or even force taxation on funds taken from pension funds in retirement. If they do any of this, there will be no incentive to put funds away for retirement.

Comments from Baker Tilly's George Bull

John Stokdyk | Wed, 14/03/2012 - 10:13 | Permalink

Baker Tilly tax partner George Bull thinks the most likely change will be a restriction in the tax relief for contributions by higher rate taxpayers so that they receive only basic rate relief. However, he suggests, "In reality this change is very difficult to implement, especially for employers who make contributions to employees pensions or who operate a defined benefit scheme. Indeed, this could have a negative effect for some earners in these organisations for whom the only visible change would be less take home pay.

"The figures show that only £6.6bn of the £33bn of pensions tax relief is given for employee contributions. £19bn of relief is given by not taxing employer contributions, and finding a way to deny higher rate relief in respect of such contributions will be something of a Gordian knot that needs a radical solution. It is not clear how you allocate employer contributions across the members of a DB scheme where there is an actuarial deficit, some of which relates to deferred members.

"Neither will any change be quick as it will need systems rewrites at HMRC, pension providers and employers, so we should expect consultation for an expected change from April 2013. An immediate change could be made through the self-assessment system but this would require tax returns from many people not in the system.

"Alternatives may include:

National Insurance levy on employer pension contributions, since the exclusion of employer contributions to registered pension schemes ‘costs’ the state £13bn each year according to recent HMRC figures.
A reduction in the £50,000 annual allowance
Radically, a requirement for pension schemes to invest a proportion of funds in, say, infrastructure projects or other Government initiatives as a bargaining for retaining full tax relief.

"Taxpayers who wish to pay large contributions that would currently attract full tax relief and who prefer safety first should do so before Budget day, in case the shutters come down overnight. However, given the inevitable complexity and the need for systems changes all round, a change at the tax year-end seems more likely."

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