What the Treasury expects to save as a result of the 60% reduction in the MPAA this April is small beer in government spending terms, says Tom Selby, yet the cost to confidence in pensions is untold.
Pension tax relief has been like catnip to Conservative Chancellors since 2010. George Osborne, prior to his brutal post-Brexit vote ousting by Theresa May, oversaw two cuts in the annual allowance during his five-year tenure.
He was also responsible for the introduction of the hideously complex annual allowance taper, which progressively lowers the amount clients can put into a pension each year. Under the rules, the annual allowance gradually reduces from £40,000 for those with earnings below £150,000, to £10,000 for those with earnings of more than £210,000.
Advice will be absolutely critical for anyone who risks being caught by the taper as contributions above the annual allowance will be hit with a tax charge.
Osborne also hacked away at the lifetime allowance, reducing it from £1.8m to £1.5m, then from £1.5m to £1.25m, and finally from £1.25m to the current level of £1m. Each cut spawned more unwelcome complexity through the introduction of a series of protection regimes.
Finally, there is the Money Purchase Annual Allowance (MPAA), introduced by Osborne to limit the risk of savers ‘recycling’ cash through their pension. The MPAA means anyone who has accessed their pension flexibly is subject to a reduced annual allowance of £10,000.
Stability was supposed to be the key theme of Philip Hammond’s first major set piece as Chancellor in November. But even this seemingly cautious politician could not resist dipping his hand in the pensions till by announcing a cut to the MPAA, from £10,000 to just £4,000. The cut will be retrospective, so anyone who has already used the pension freedoms based on the old £10,000 MPAA will also be subject to the new, lower allowance.
To justify the move, the Treasury said: “The Government does not consider that earners aged 55 and over should be able to enjoy double pension tax relief, such as relief on recycled pension savings, but does wish to offer scope for those who have needed to access their savings to subsequently rebuild them.”
So exactly how big a risk is this to the Exchequer? The Treasury expects the policy to save around £70m a year – small beer in government spending terms.
Cost to confidence
The cost to confidence in pensions, however, is untold. Anyone who has already accessed their pension flexibly on the premise they could still save up to £10,000 a year tax-free will feel justifiably angry their annual allowance has now been slashed by 60%.
One solution would be to allow those who have already used the pension freedoms to retain the £10,000 MPAA, while anyone who did so in future would be subject to the new, lower allowance. This would, however, be unwelcome and add another layer of complexity to an already horribly complicated system.
Anyone who accessed their pension from April could also justifiably ask why their annual allowance is lower than someone who just happened to use the freedoms a year earlier.
There is another, much simpler way of avoiding such unfairness at minimal cost to the Exchequer. Leave the MPAA at £10,000.
Such radical thinking might be anathema to the Treasury given its apparent preference for tax relief tinkering. But it is also the most straightforward route out of the hole the Chancellor has dug for himself.
Tom Selby is a senior analyst at AJ Bell