TIME and tide sure do change when it comes to pension planning. It seemed only yesterday we were being bombarded with warnings over pensions. We were told we were not saving enough; we had to make far bigger payments into our pension “pots” to see us through our longer retirement lifespan.
This commentary has turned into near panic with the onset of ultra-low interest rates. The interest stream on our pension savings been drastically reduced. And annuity rates have been plunging. All this has come on top of the tax raid on pension fund dividend income which has reduced the savings built-up in our pension funds (thank you, Gordon Brown).
So what is the point, many have now come to wonder, of saving through a pension scheme at all, looking at the miserable returns now in prospect?
The argument, quickly advanced by the industry and an army of independent financial advisers, is that generous tax relief still means that pension saving is the better option, even though the returns are down on what we could have expected (and what was being paid out) only a few years ago.
Now the music is changing. A cash-strapped chancellor looks set to announce a lowering of the annual contribution we can make into pension pots because well-off folk are benefitting disproportionately and should be required to bear their burden of sacrifices to help bear down on government deficit and debt.
The argument for curbing the tax relief on annual pension contributions looks powerful. It is costly (in terms of tax revenue foregone). And there is an argument on the grounds of fairness. Why should millions so poor that they cannot afford to make pension contributions at all effectively subsidise people who can get full tax relief on contributions of £50,000 a year?
A powerful paper putting the case for a tax relief cut has come from the right-of-centre Centre for Policy Studies. Pensions expert Michael Johnson sets out why pensions tax relief should be reformed. He calculates that over the past ten years £360 billion of tax revenue has been “foregone” (adding up the tax relief on contributions, the tax foregone on lump sum payments, the tax lost on employer contributions and tax lost on sheltered investment income ) and that much of this has been “misguided and ineffectual”.
The pension tax relief overall for 2010-11 has been reckoned at almost £33bn. Of this, the amount enjoyed by those paying tax relief at 40 per cent and over has been estimated at £7bn. Some £3bn of this relief on contributions is thought to go to a maximum of 250,000 people earning more than £150,000 a year.
A further reduction in the maximum annual contribution from £50,000 to £40,000 or even £30,000 would not save the chancellor very much (£600 million and £1.8bn respectively). More tempting for him would be to go for Johnson’s favoured option of removing higher rate tax relief altogether on contributions. This would save Osborne £7bn.
However, such would be the political outcry that the chancellor is more likely to proceed modestly, with a lowering of the contribution ceiling. Now a maximum annual contribution to a pension scheme of £40,000 still sounds a large amount. But there is a specific objection and a general one.
Self-employed and partnerships will object that having been unable to make any contributions for many years they would now be unable to “catch up” with large contributions in the later years.
The general objection is that higher rate taxpayers are already paying a very large percentage of total UK income tax, their personal allowances have been foregone together with loss of child benefit. In any event, income tax at up to 40 per cent is still payable on pension income in retirement, making the scheme not so much tax relief as tax deferral. So further curbs here would be seen as yet another handicap for the aspirational and enterprising.
An alternative is to remove the tax-free status of lump sum payments of up to 25 per cent of the pension fund on retirement, but this would be ferociously unpopular.
There is a further proposal in the centre’s paper that would attract support from savers: a lift in the top limit of annual Isa savings. This could be achieved by combining the annual contribution limits for Isa and tax-relieved pension saving into a single limit of between £30,000 and £40,000 a year.
This would be popular on several grounds. It would overcome the distrust that many feel towards big insurance company managed pension saving schemes. It would give the individual more control over the underlying investments. And there would be the freedom to withdraw funds before reaching the designated retirement age.
However, this might be the very reason why the proposal would struggle for approval. Governments are terrified of the prospect of millions in pensioner poverty demanding hand-outs. There would need to be powerful ring-fencing between the Isa element and the pension pot under the overall tax shelter.
Whichever way he turns, the chancellor faces trouble. He has to find savings of £10bn to bring his deficit reduction target into line. That is why a lowering of the tax relief for pension contributions looks more likely than not.