Incentive synonyms include catalyst, drive, enticement, inducement, influence, inspiration, persuasion, purpose, rationale and reason. It is worth keeping this in mind when considering recent Government intervention on pension incentives. In the 2009 Budget, the Government announced its intention to introduce measures to reduce the tax relief on pension contributions available for those earning more than £150,000 a year. The measures are to take effect from April 6, 2011.
At the time of the pre-Budget report, the Government announced a formal consultation period ending on March 3, 2010. HM Treasury produced a detailed consultation document covering 124 pages setting out a number of proposals relating to the restriction of tax relief and HM Revenue & Customs published draft legislation to accompany the Treasury document. In the midst of the 124 pages, we are introduced to a three-stage process for restricting tax relief.
Step one – looking at the individual’s income
Individuals with pre-tax income of less than £130,000, including their own pension contributions and charitable donations, are not affected. Individuals with pre-tax income of £130,000 or more, including their own pension contributions and charitable donations, will only be affected if the sum of their pre-tax income and the value of employer funded pension benefits is £150,000 or more.
Step two – determining the appropriate rate of tax relief
The Government plans to restrict tax relief on pension contributions by the introduction of a taper for those with “gross income” between £150,000 and £180,000. This taper needs to be structured in such a way that it copes with situations where tax relief is being granted at two different rates.
Step three – applying the restriction on tax relief
The taper will establish a maximum level of tax relief for all income levels between £150,000 and £180,000 via a series of stepped changes. It would appear the Government is proposing to deal with this at the £1,000 level so the maximum rate of relief at any income between £150,000 and £151,000 is 49 per cent, £151,001 and £152,000 is 48 per cent and so on. Any tax relief that would have been above this amount will be reduced to the maximum rate of relief.
We could, of course, adopt a different approach. Reducing the annual allowance was discounted because it was believed that this would constrain the tax privileges for everyone and allow highest earners to receive more per pound saved than basic-rate taxpayers.
The aim of any incentive system must be to act as a catalyst while driving and influencing saving behaviour. A new annual allowance of, say, £30,000 to £50,000 would be simple for all to understand and could achieve this. It would also change the balance and spread of tax relief to ensure a fairer split while avoiding migraines for all of us who work with the current rules.
The most compelling argument is that investors do not like confusion and complexity. It has a nasty habit of getting in the way of rationality and reason.