Higher earners are being urged to maximise their pension contributions ahead of the 2017 Budget amid concerns the Chancellor will scrap higher rate tax relief. The move would be the latest in a long line of measures that have hit the wealthy middle classes.
In April 2014, the annual allowance was reduced from £50,000 to £40,000. This was followed by the introduction of an annual allowance taper this April, which reduces higher earners’ annual allowance by £1 for every £2 of income they receive above £150,000.
On top of this, the pension lifetime allowance was slashed again, falling from £1.25m to £1m.
Many experts predicted the scrapping of higher rate tax relief in the 2016 Budget, but this did not happen in the end. Richard Parkin, head of pensions policy at Fidelity International, said most people believed this was a stay of execution rather than a full reprieve.
“While we do not expect tax relief reform to figure heavily in the Autumn Statement, we do think it will be back on the agenda before too long. The need to manage government spending and the perceived unfairness of the system both make it a political target for the new May government.
“It therefore makes sense for higher rate taxpayers to make the most of the relief while it is still available. Should a change come, there may be little opportunity for people to make additional contributions at that time.”
The government’s clear intention is to have a regime that encourages greater saving among those who can least afford it, but in a manner that is no more expensive for the government.
Martin Tilley, director of technical services at Dentons Pension Management, said this means those who are wealthy enough to make alternative means will lose their current tax incentives at some point. The well-known tax bands are 20%, 40% and 45%, but there also exists a threshold above which personal tax allowances are removed.
“Thus, on the band of earnings between £100,000 and £122,000, an individual will have an effective tax rate of 60%, so anyone falling into this band should certainly look to use the current reliefs while they still can,” Tilley said.
Even if higher rate tax relief is not scrapped, maximising contributions ahead of the Budget could still be beneficial. In 2015-16, there was a change in the pension input periods which meant some members could use their annual allowance over again.
Claire Trott (above right), head of pensions strategy at Technical Connection, said this is not likely to be the case again, but there could be other policy changes to take advantage of.
“The rules with pensions are rarely, if ever, retrospective. As long as the client is not leaving themselves short and intended to pay the contribution anyway, they won’t be any worse off and may benefit if changes are favourable.”
Many in the industry prefer a flat rate system of tax relief, and believe favouring higher earners is unfair. Parkin (right) pointed out that for those who remain higher-rate taxpayers in retirement, tax relief generates a return of about 17%.
If they become basic rate taxpayers in retirement, this rises to 42%. By comparison, a basic rate taxpayer who stays in this band in retirement gets a return of 6%.
Parkin argued that upfront incentives should be sustainable and have universal appeal – encouraging greater saving among lower earners without disenfranchising the more highly paid.
“This leads us to favour a flat rate of tax relief of 25%,” he said.
In contrast, Trott suggested that with the variations in scheme structures in place today, the annual allowance is the best way to limit contributions for all.
“Should we go to something as simple as a flat rate, then there will be significant issues added to the way in which employer contributions are limited, salary sacrifice would not be possible and final salary schemes would become even more complicated.
“Other proposals will have similar issues because as soon as you change the amount tax or bonus paid to individual’s pension schemes, you need to monitor the amount going in from the employer.”
An alternative model put forward is one that weights incentives towards younger people to encourage people to start saving earlier.
Tilley said this would be less complicated than basing incentives on earnings, which fluctuate and are not generally known until the end of the tax year. He suggested using age bands of up to 20, 21-25, 26-35, 36-45 and so on.
“However, while that might be what we see, it does not fit all. Many individuals have other pressing financial demands and are not able to contribute substantially to a pension until they are in their 40s or 50s. There is no panacea,” Tilley (right) added.
Whatever happens, there is a clear wish in the industry for the government to end its constant tinkering of pension tax rules. Research by Dentons showed that one of the biggest barriers to increased pension saving is people do not trust ministers with their pension fund.
“Constant changing of the rules around pension taxation increases complexity and undermines trust – an essential ingredient of creating a sustainable pension system,” Tilley said.
“Whatever changes are made, they need to be for the long term and not invite further tinkering over coming years.”