Since the freedom and choice regime was introduced last year, pensions have been a constant source of headlines.
Only recently we have heard that the Government is not to proceed with the implementation of a secondary annuity market. And in the run up to Chancellor Philip Hammond’s first Autumn Statement on 23 November, there appears to be a growing expectation of some (possibly quite material) change to pension tax relief.
The cost of pension tax relief – at over £30bn – is the most obvious driver behind this. But a more fundamental question for the Government is whether the current method of offering tax relief on pension contributions is meaningfully changing the behaviours of those under-contributing. Answer? Probably not.
So is it the amount of relief given or the way in which it is given that is the main impediment? A bit of both really. Proponents of the Lifetime Isa might argue strongly for the latter.
The Lifetime Isa gives a bonus of 25 per cent of the contribution made but this amounts to the same as 20 per cent on the gross contribution: for example, £2,000 contributed equals £500 bonus, and £500 equals 20 per cent of £2,500. Get it? The key here is that the bonus is characterised as, and represented by, cash. It is added to the account at the end of each year.
Assuming he is not going to completely ditch pensions as we know them in favour of an Isa-like regime, what moves might Hammond make to change tax relief, then?
“A fundamental question for the Government is whether the current method of offering tax relief on pension contributions is meaningfully changing the behaviours of those under-contributing. Probably not.”
A flat rate fix?
Some form of flat rate relief seems to have support, with 30 per cent one possibility mooted. It does not take much thought to appreciate that higher rate taxpayers paying into a pension will be worse off with a flat rate of 30 per cent: 25 per cent worse off for that matter. However, basic rate taxpayers would see a 50 per cent increase in their rate of relief.
Of course, if there is a move to flat rate tax relief, measures are likely to be put in place to ensure financial parity between the self-employed paying contributions direct and those receiving additions by corporate contributions. A negative adjustment for higher rate taxpayers and a positive one for basic rate taxpayers would be necessary.
I should reaffirm that none of this is based on fact; just informed rumour. But for the sake of argument, let’s ask: what can you do if you might be worse off under a flat rate system of tax relief?
Well, for starters, you might want to consider making a contribution towards your pension plan ahead of the Autumn Statement.
There will need to be a check on your contribution capacity, taking account of everything past and present. Remember you can take account of any under-contribution over the past three tax years: the difference between the maximum contribution possible for and the amount actually paid in each of those years. Obviously, once your contribution capacity has been quantified, you should check that neither the lifetime nor annual allowance represents a challenge to the amount you wish to contribute.
Before committing to payment it is important to assess whether there is any chance of higher rate taxpayers being more favourably treated under any new system of tax relief. Most would conclude this risk is low to non-existent. Then, assuming the contributions will fully qualify for tax relief at the higher rate, the key non-tax question is whether you would have been happy to make the contribution regardless of the risk of a change in the tax relief rules taking place. If the answer is yes, then go ahead. If the answer is no, then think twice.
If you are a basic rate taxpayer, subject to the importance of any other factors such as the timing of investment, it might pay to defer contributions to pensions until after the Autumn Statement. As mentioned, if the move to a flat rate takes place you might see your rate of tax relief increase by 50 per cent.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn