Prepare for a bumpy ride on pensions

A perfect storm is coming, warns Norman Dalgleish

Picture: PA
Picture: PA

‘Nothing can be said to be certain, except death and taxes.” In 1789 Benjamin Franklin could see only two certainties in life, but if he were alive today he may have to add “pension legislation will change” to his short list.

In his summer 2015 Budget, Chancellor George Osborne confirmed some previous announcements and made other new ones. As a consequence, next April is rapidly turning into a perfect storm for many of those who had been planning to make pension contributions in the coming years. There are now strong tax reasons to secure the maximum amount of tax relief available by making contributions in the current tax year.

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Those potentially affected should be calculating the maximum contribution they can make now. This will depend upon what other contributions have been made in the last few years, the level of income in the current year, and the level of cash resources to fund any contribution. This potential contribution should then be reviewed, alongside the value of existing pensions, against the lifetime allowance. For some, a large contribution before April may be essential, but for others with large funds it may already be too late.

Perhaps even more significantly, the Chancellor has launched a consultation on the entire structure of the pension tax relief system.

The consultation document talks about “strengthening incentives to save” and offering “greater simplicity and transparency”. However, it is also clear that much of the motivation is less philanthropic and more austerity related, ensuring that the “system is sustainable”.

Pension contributions “cost” the Chancellor via lost income tax and National Insurance. In 2013-14 the total cost of these was nearly £50 billion. This is partly offset by income tax received on pensions currently in payment, but this only amounts to around £13bn per annum. The Chancellor is keen to reduce the net difference, particularly as the tax relief cost has been gradually increasing in recent years for a wide variety of reasons.

The other strategic issue is about the distribution of the tax incentives. Currently, around two-thirds of the tax relief goes to higher rate taxpayers. The Chancellor would prefer to distribute this more evenly. One solution, favoured by the recent Pensions Minister Steve Webb and others, would be to have a single rate of tax relief, perhaps 33 per cent, regardless of an individual’s personal tax rate. This would be an increase for basic rate taxpayers, and a reduction in support for those paying higher rate. However, while clear and simple in principle, this would come with significant complications, particularly for defined benefit (final salary) scheme members.

The Chancellor has explicitly stated that the conclusion may be that the status quo is the best option. However, the green paper also makes the comparison with ISAs. If a similar structure was transferred over to pensions then it would mean the effective removal of “tax relief” on pension contributions, with the accompanying benefit of no income tax when pension income is received. It is easy to see the benefits to the Chancellor: short term tax receipts would increase (as no tax relief on pension contributions), and it would effectively remove the 25 per cent “tax free lump sum” that is currently available.

A more moderate solution may be via changes to the already existing annual and lifetime allowances.

The consultation runs to the end of September. The hope is to find a solution that is simple, sustainable and that encourages pension saving.

Back in 2004, the then government introduced what they optimistically called “Pension Simplification”, but since then the regularity and scale of change has been anything but simple.

The summer 2015 Budget continued this tradition. It remains to be seen what effect this constant tinkering has on the level of pension saving: how confident can a 25-year-old be about putting money into a pension today when they don’t know what the rules will be next year, let alone in 50 years’ time?

Perhaps there is a fourth certainty for Benjamin Franklin’s list: you should always seek advice from a suitably qualified (chartered or certified) financial planner before making any significant pension related decision!

Norman Dalgleish is a wealth and pension planner with Morton Fraser