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Indirect consequences

Raising the income tax threshold could spell trouble for pensions

It was a Budget that proved the doom-mongers wrong. Higher-rate tax relief on pensions, insurance premium tax and salary sacrifice in its typical form all came out unscathed. And to cap it all, the Treasury gave its backing for the DWP’s plan for a single flat-rate pension payable to all.

All in all, a pretty good Budget for those working in workplace benefits but there are still some fairly hefty wrinkles to sort out, most significantly the problem of contracting-out rebates on public sector pension schemes. The good news is that it looks like the Government will have to set out its stall within the next six weeks if it is to make the spring deadline set by the Chancellor in his Budget speech. The sooner the issue is addressed, the better as far as auto-enrolment is concerned.

Pensions themselves may not have been directly affected by tax changes announced in this year’s Budget but there are potential indirect consequences.

The raising of the income tax threshold to £9,205 will impact auto-enrolment if the Government continues with its approach of linking the auto-enrolment qualification threshold to it. Not only would increasing numbers of workers be excluded from auto-enrolment but there would be real complexity when those workers near the limit qualify but do not get tax relief.

The Government is clearly sympathetic towards the prospect of more low-paid workers being taken out of auto-enrolment, given the way it has already saved itself and employers money in postponing the roll-out of employer duties.

The decision to take forward Adrian Beecroft’s proposal to delay auto-enrolment roll-out will have saved the Treasury £380m by 2017, according to documents published with the Budget. And the latest delay that the DWP is now consulting on could ultimately save it a further £1.1bn as staging dates are strung out to 2018.

Even more can be saved now by tweaking the auto-enrolment parameters at the edges. Aon Hewitt calculates that increasing the threshold to £9,205 would save employers £100m a year. If the coalition’s stated aim that nobody earning less than £10,000 a year should pay income tax is to be achieved and the link to the income tax personal allowance is retained for auto-enrolment qualification, many more low-paid workers will be taken out of the process. That will not only save the Treasury and employers money but will also reduce the amount of tiny pots floating around the market.

However, such an approach would create complexity. Low earners automatically enrolled into trust-based schemes will in some circumstances end up with either no tax relief or not full relief, where they earn just more than the threshold, making the prospect of opting out much more likely.

Some individuals may also find they have tax relief one year but not the next if the income tax threshold rises steeply. Obviously no-one wants to pay tax and all low earners will welcome a higher threshold but it will create communication problems for pension schemes.

Some argue employees will be able to reclaim full relief from the Government by filing a tax return. Asking those on very low incomes in trust-based schemes to follow such a route is probably asking too much. Whether this leads some trust-based schemes to switch to receiving tax relief up-front to help these members, or to install a parallel contract-based scheme for these workers, remains to be seen.

It is not yet definite that the auto-enrolment threshold will be pegged to the income tax personal allowance – but it is on the agenda. Keeping it there has benefits but it also has a price in terms of pension undersaving. Take the business-friendly attitude towards auto-enrolment too far and the fundamental point of the whole policy could be lost.

John Greenwood is editor of Corporate Adviser

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