Working out how much you can put into a pension has never been the easiest thing. Over recent years, the variations on the annual allowance has only made it harder for higher earners and those seeking to access their benefits earlier in life.
The issues could be enough to restrict the amount people pay into their pensions later in life and, in the worst case scenario, could mean tax charges for the individual.
When the annual allowance was at £255,000 there were not many people who would have been able to make personal contributions anywhere near such a level. But in recent years we have seen the headline figure drop to £50,000 and then £40,000. We now have some people with an annual allowance as low as £10,000 just because they are successful and have high earnings.
I do not so much disagree with having a lower rate for high earners but I do disagree with having a variable rate so complex it is virtually impossible to calculate an individual’s allowance accurately in the tax year in which the contributions should be paid. Yes, you can use carry forward but this brings additional complexities with regards to tax relief in itself.
Virtually everyone will be hit by a reduction in the annual allowance at some point in their lives, unless they are lucky enough to be part of a final salary scheme or if they decide to buy a traditional annuity.
The money purchase annual allowance drops the annual allowance from £40,000, or their tapered amount, to £10,000 for money purchase contributions when benefits are accessed “flexibly”. Not for final salary accrual though. They can still use the whole annual allowance as long as no more than £10,000 is used for any money purchase contributions.
These reduced annual allowances may not be a problem for everyone but they do make planning harder in the long run. Indeed, you do not know what will happen in the future, so you cannot count on always having £40,000 to play with should you need it. Take into account the fact the Government has implied that taking your benefits as early as 55 is perfectly fine. We may be storing up issues if they are not addressed.
“I do not so much disagree with having a lower rate for high earners but I do disagree with having a variable rate so complex it is virtually impossible to calculate an individual’s allowance accurately in the tax year in which the contributions should be paid.”
The Autumn Statement could be used to clear up this mess. The Government has shown with the cancellation of the second hand annuity market that it is not afraid to undo past mistakes. And these are clearly mistakes that need undoing.
Pension freedom and simplification should be making it easier for people to understand what they have already saved, what they can save and what it will mean for their retirement. But it is just getting worse each time a new layer of change is added.
I am sure these changes were added for a good reason – the money purchase annual allowance to stop income recycling and the tapered annual allowance to try and restrict tax relief for high earners – but they were clearly never thought about together.
We need a sustainable annual allowance to be introduced, even if this is less than the current £40,000. The majority will not be impacted by a reduction but it will mean clarity and that is what is missing at the moment.
Keeping carry forward could allow for unusual spikes in contributions due to redundancy or a bonus payment. This is not in the same league of complexity as the tapered annual allowance. It has even become simpler since pension input periods were tagged to tax years.
The Government has the opportunity to sort out this mess without causing any real disadvantage to the majority or giving away excessive amounts of tax relief to high earners. The simplicity it will bring may well even save money in the long run.
Claire Trott is head of pensions strategy at Technical Connection