As we anticipate a new system of pensions tax relief, the case to make the most of your savings power now before 6 April is stronger now than ever.
Four weeks left. That’s all we have got to go until the biggest change to pensions. Ever. (And given the momentous events of the last few years – 1988, simplification, pensions freedom – that is saying something!)
Four more weeks to go to Budget Day. Then George Osborne will announce a new system of tax reliefs for pensions. Retaining the status quo is probably a no go. So, the two main runners are moving to a ‘taxed exempt exempt’ (TEE) arrangement, where contributions are paid from taxed money, but the proceeds can be taken totally tax free (a pension ISA). Or a flat rate of tax relief where everyone receives the same rate of tax relief regardless of what tax they pay on their earnings.
At the moment, it’s this last option that is the bookie’s favourite to go ahead. Which, given the choice between the ‘rock’ and a ‘hard place’ options in front of us, is probably a good thing. There is no doubt in my mind that moving to a pension ISA position would be the final unravelling of pensions. There would be no incentives left to offer a good pension scheme, and employers will simply fall back to the statutory 3% of band earnings.
I would much prefer we kept the present system. It demonstrates the clear position as pensions as deferred pay (which is what they are), and incentivises higher and additional rate taxpayers to pay in money for them and for their workforces.
At least if we move to a flat rate tax relief system of somewhere in the band of 25% to 33% someone will benefit. Basic rate taxpayers will get more tax relief paid into their pension plan. But higher rate taxpayers will probably receive much less (depending upon the exact rate of tax relief chosen) and additional rate taxpayers will benefit least.
However, moving to a single rate tax relief may not prove to be the big incentive to save more some are claiming it will be. For someone earning £24,000 and paying 20% tax, if their own contribution is 3% of salary, then they pay in £60 a month, and the government currently tops it up to £75 a month. Move to a 25% single rate tax relief, then the government will top it up to £80 a month. Only £5 a month more. That will probably not set the world alight, and won’t fire up many to suddenly save more in pensions.
As well as the question of what tax system will pensions move to, it’s uncertain when will this change take place.
It could be all change on 6 April 2016, but that seems a big ask. For all the providers out there with creaky admin systems, the big pension schemes, and HMRC itself, there is a fair bit of work to be done to move to the new arrangements.
So, April 2017 seems more likely. However, that would give a year’s warning to higher and additional rate taxpayers that these changes will come in, and would incentivise them to pay as much as they can in 2016/17. The government might be OK with that – after all, it has the reduction in the lifetime allowance to £1 million and the introduction of tapered annual allowance to temper people’s pension expectations and to keep a lid on an influx of contributions next year. But it could choose to bring out other measures to stop this behaviour – say a much lower annual allowance, to be effective from Budget Day to implementation in April 2017.
Remember these tax relief changes don’t just affect those additional rate taxpayers or those with big substantial pension pots. It affects most higher rate taxpayers now. And the biggest winners from the current system are those who are higher rate whilst earning and basic rate when taking the money out. These people may see the biggest fall in tax advantages when the new system is introduced.
So, it makes sense for all higher rate taxpayers to think about making additional contributions now before the new system is introduced. And, if you believe the government will bring in additional constraints in the run up to implementation date, then that gives only four weeks to complete the paperwork.
Pensions are about to undergo a transformation. Many will see a reduction in their saving power, so it makes sense to make the most of what you have now, and to contribute what you can before the change.