April 2008

Pensions and the Budget

This year's budget was a fairly low key event with tax increases to alcohol, tobacco and car duties grabbing many of the headlines. However, there were several changes which have an impact on pensions.

A cut of 2p in the basic rate of income tax from April was pre-announced in last year's budget. At the same time, the 10% starting rate of tax has been scrapped, and the ceiling for the standard 11% rate of National Insurance (NI) has risen by £3,900 more than the usual inflation-linked rise.

These changes are more about simplifying the number of rates and bands than cutting tax bills, so some people will gain a little and some people will lose a little. The biggest winners will be those earning around £35,000 a year who will be around £32 per month better off. The biggest losers will be those earning £15,000 a year or less as they will have more of their income taxed at 20% rather than 10%. An individual earning £8,000 will be around £12 per month worse off.

These changes also affect pension payments as basic rate taxpayers now only get 20% tax relief on their contributions. As a result, to invest £1,000 in a personal pension a payment of £800 is required rather than the £780 which needed to be paid before April. People can also reduce the tax burden imposed by the increase to NI by using salary sacrifice arrangements to pay their pension contributions.

The Government also made changes which will allow people to take very small benefits from occupational pension schemes as a lump sum. The new rules will look at one scheme in isolation and allow benefits to be paid as a lump sum where the value is below £2,000. This allows people to take very small benefits in one occupational scheme as a lump sum under the triviality rules while receiving an income from another, larger, pension pot.

Forcing people to buy annuities with very small pension pots means they don't receive good value for money. So allowing small pension pots to be paid as a lump sum even though people may be receiving income from other, larger, pensions is excellent news for consumers. But it is very disappointing that the Government has restricted this change to occupational schemes.

A further change closes a loophole which allowed pension funds to be passed on tax-free at death. Providers of small self-administered pension schemes (SSAS) have been marketing scheme pensions as a way of passing pension money onto family free of tax since A-Day. However, the Treasury has clamped down on what it regards as an abuse of the rules. This change was expected and, from the Government's perspective, is a logical step which brings scheme pensions into line with alternatively secured pensions. But from a wider viewpoint, the tax rate of 82% applied to inheritances under both routes is unnecessarily punitive and will not do anything to encourage more pension savings.

Looking at all of the pension-related changes in the Budget, it is unfortunate the Government's main drivers appear to be stopping perceived abuse rather than encouraging people to save for their retirement. For example, consumers who have very small personal or stakeholder pensions face the same difficulties as people with small occupational pots and should be allowed the same flexibility to take their small pots as a lump sum. It seems bizarre for the Government to start re-introducing different rules for occupational and personal pension schemes, reversing the tax simplification changes introduced only two years ago.

Andrew Tully
Senior Pensions Policy Manager
Standard Life