The way pension tax relief works is reportedly under review by the Treasury.
The apparent proposal is focused around a new flat rate of tax relief of 25% on pension contributions, regardless of personal income tax rates. Under this scheme, a gross pension contribution of £100 would require the same of everyone – a net outlay of £75 rather than the current £80. Pension tax relief is currently given based on your personal income tax rate, which means most people get basic rate relief at 20%, but high earners can get 40% or 45%.
The 25% rate would be a tax cut, in effect, for anyone other than those paying only basic rate tax, but could also potentially save the Exchequer around £4 billion a year. Increasing the flat rate to 28% would cost the Treasury the same as today’s mix of 20%, 40% and 45% reliefs, according to estimates from the Resolution Foundation.
With the government looking for an extra £20.5 billion in funding for the NHS, it isn’t surprising that pension reliefs are under consideration. Tax relief on pension contributions cost the Exchequer £38.6 billion in 2016/17, according to HMRC’s latest estimate, as well as over £16.2 billion of national insurance contribution (NIC) relief on employer contributions.
The government has eroded the value of pension relief over recent years by reducing the annual allowance: it is now £40,000, but in 2010/11 was as high as £255,000. While these more radical changes to tax relief would be politically sensitive – and the Chancellor has already experienced a backlash after his proposed increase of NICs in 2017 – the Treasury Select Committee has recommended the government give it “serious consideration”.
With the government needing to find money from somewhere, and more voices calling for a move away from full tax relief, a significant change to pension reliefs may be inevitable. Whilst in principle this might seem like a sensible idea, this is an area fraught with difficulty for this and subsequent generations, both in the populus and in Government.
The dilemma for the Government is that there needs to be an incentive for individuals to continue to save for retirement. There has been an increasing focus on encouraging individuals to make their own provision, which is turn has meant that progressive cuts could be made to the State Retirement Pension thereby limiting future spending commitments; the Auto Enrolment legislation is evidence of this If tax relief on personal pension contributions is pruned back, this means that less provision will be being made by individuals and there is likely to be a consequent effect on the financial propriety of future generations unless corrective action is taken. We can therefore expect to see further ‘awareness’ messaging and possibly even further compulsory provision rules.
It is worth highlighting that the proposals to restrict pension tax relief only relate to contributions paid personally. Many of our clients are in a position of control within their own business and have the ability to pay contributions from the company as part of their remuneration structure. In the right circumstances, this can still be an extremely tax-efficient means of paying contributions, which could also be thought of as a tax-efficient means of extracting value from a business. Additionally, for those in employment, it may be possible to engage in a salary sacrifice arrangement with your employer, which is likely to provide a boost to your pension contributions by virtue of the savings on National Insurance Contributions and could effectively circumvent the proposed restriction on pension contribution tax relief.
As with all matters in the financial planning area, particularly relating to pensions, it would be sensible to adopt a measured approach and to consider all of the available options before making any specific decisions, particularly if substantial amount of funds are involved.