Various thinktanks and politicians have decided that it is time to attack the tax privileges enjoyed by registered pensions. The Centre for Policy Studies reckons the total cost over the last decade is at least £360bn. Advisers need to decide how to deal with the problems this raises in their advice to clients, steering a fine line between the responsible – raising awareness – and the inappropriate – scaremongering.
Arguably, the most credible attack on pensions came earlier this year from the Institute for Fiscal Studies, which described the tax regime for employer pension contributions as “extraordinarily generous” and called on the Government to make these inputs subject to employer NICs.
Pension contributions by employees and self-employed people don’t benefit from this particular relief. But employer contributions go straight to the pension provider and so escape the 13.8 per cent NIC liability, which is a tax in all but name. They also escape employee NICs, which are 12 per cent or 2 per cent, depending on the employee’s level of income.
The IFS also argues that the Government ought to restrict people’s ability to withdraw tax-free lump sums from larger pension pots.
In contrast, the generally right- wing thinktank Centre for Policy Studies has recently argued that tax relief on pension contributions should be scrapped altogether. In its view, the relief primarily benefits higher-rate taxpayers and does little to inspire low earners to save for retirement.
The CPS also favours retention of NIC relief on employer contributions to encourage employer engagement with pensions but wants to abolish the 25 per cent tax-free lump sum. It proposes various compensations for the removal of tax relief, including a single flat-rate tax relief of 25 per cent or 30 per cent to incentivise low earners to save and a combined contributions limit of £30,000-£40,000 for pensions and Isas.
Then just before the CPS report was published, LibDem pensions minister Steve Webb argued for a flat-rate 30 per cent relief for all. Under a Labour government, higher rate tax relief would be under threat and the lifetime allowance might be reduced further.
Faced with these high-profile suggestions and an election in May 2015, what should advisers recommend to clients about their pensions? Advisers need to explain that governments of all political shades will be under pressure to raise cash and that the tax relief on pensions is expensive and is perceived as mainly favouring the relatively rich. The coalition government has cut back on pension tax privileges and more left-leaning governments might well go further.
But there is another general point that suggests a very measured approach. Successive governments have generally not legislated retroactively on pensions. Even where they did, as in the 2006 so-called “simplification” revolution, protection was introduced for people with large pension pots who would otherwise have been caught by the lifetime allowance.
The tax-free lump sum seems to be under a variety of possible threats so it could be argued that clients should take the lump sum as soon as possible before it is abolished or further limited in some way. The trouble is this approach could turn out to be expensive for clients who would otherwise benefit greatly from the flexibility to take tax-free amounts each year and bring down their tax rates substantially under the new drawdown regime. This kind of “new style” phased retirement would be closed to them if they decided in a panic to take all their lump sum now.
The other area for advisers to think about is the possible change to tax relief on contributions. That might mean more tax relief for basic-rate taxpayers and would almost certainly mean less tax relief for 40 per cent and 45 per cent taxpayers.
It could be pretty irresponsible to suggest to a 20 per cent taxpayer that they should postpone making pension contributions because more tax relief might be in the offing in a year or so’s time. The uplift might not turn out to be very significant and missing out on several years’ fund growth would be a mistake. Any client who took this line would need to make sure they kept saving for their retirement in other ways – perhaps through the new Isa.
But it might make sense for higher or additional rate taxpayers to invest as much as they can in pensions in the next year or two – assuming it fits into their financial priorities.
Danby Bloch is editorial director of Taxbriefs Financial Publishing
Pensions flexibility – the new rules
Keep your clients up to date with a personalised guide to the new rules and proposals announced in the Budget affecting retirement income. The latest edition to our Key Guides series covers:
- Revisions that took effect from 27 March.
- Total drawdown flexibility that should be available from April 2015.
- New Class 3A NICs.
- Likely increases to the minimum pension age.
- Reductions on death benefits for some individuals.
To find out more, contact Alex Broughton on 020 7970 4196