Another year, another Budget and yet more changes to pensions. Bizarrely, change seems inevitable now. This first Budget of the new Conservative Government has one relatively minor, yet horribly complex, change which affects higher earners. Alongside that there is a blockbuster measure considering whether we should rip up the pension tax rule book and start again, perhaps moving to an Isa-style system.
The green paper considering the changes to pension tax relief is short but hugely important. Pension tax relief is designed to provide an incentive for individuals to defer income until their retirement. The cost of this tax relief is significant, and the Government is considering suggestions on whether and how the current system could be reformed.
It is positive the Government is moving slowly and consulting widely on this, unlike the retirement changes announced as a fait-accompli in 2014. A move to a taxed, taxed, exempt system would have major ramifications. It may be simpler for people to understand, however it is questionable if a simpler system would necessarily encourage greater savings. It would also come with many complexities, as existing pension savings would need to be ring-fenced, and it is far from clear how a defined benefit scheme could be converted to an Isa-style system. Which leads to a possibility any move would only affect defined contribution schemes, leaving defined benefit savings under the current system. That would be a controversial move, further widening the inequality between public and private sector workers.
The green paper is at an early stage, so it is likely to be a number of years before any changes are introduced. In the meantime, the Government is pressing ahead with a move to reduce the annual allowance for higher earners from April 2016. Those with adjusted annual income above £150,000 will see the annual allowance gradually reduced from £35,000 for annual income of £160,000 down to £10,000 for those with annual income of over £210,000.
However, the complexity is in the definition of adjusted income. This includes personal and employer pension contributions, and means the reduction in annual allowance potentially affects many more people. For example, if I had income of £130,000 and an employer pension contribution of £40,000, my annual allowance would be limited to £30,000.
To ensure the measure is focused on high earners, people who have income below £110,000 (excluding pension contributions) will not be affected. This is all very complicated, even for seasoned pension geeks like me.
One major difficulty is many people – including self-employed and those who get end-of-tax-year bonuses – will not know their income until after the end of the tax year. And so won’t know what level of tax relief they may receive, meaning the possibility of a surprise annual allowance charge.
This Budget gives the pension industry much to consider, and yet more changes to communicate to our customers.
Andrew Tully is pensions technical director at Retirement Advantage