Evidence points to the recent changes stalling individuals’ desire to contribute to pensions
The cost of pensions tax relief is one discussion that never quite goes away. Instead, there seems to be constant speculation both on the current costs, whether it is sustainable and, more importantly, whether the Government – this one or a future one – is going to address it.
HM Revenue & Customs recently published the cost of pensions tax relief for 2016/17. A quick glance at the headline cost brought a sigh of relief from the industry: it had stayed the same over the last two years.
However, this was a period when pension membership was increasing at a fast rate, thanks to automatic enrolment. All things being equal, should the cost of pensions tax relief not have also increased?
As usual, the answer is never simple. There are several factors at work here and, in reality, the cost keeps changing in response to government and regulator policy, as well as market conditions.
The table below shows the cost of registered pension scheme tax relief
Cost of registered pension scheme tax relief (£ million)
|Occupational scheme contributions|
|– By employees||4,200||4,400||4,500||4,500||4,600|
|– By employers||18,400||17,000||16,600||18,600||18,000|
|Personal pension contributions|
|– By employees||1,700||1,800||2,200||2,400||2,400|
|– By employers||3,000||3,100||3,300||4,300||5,100|
|Contributions by the self-employed||700||600||600||700||700|
|Investment income of pension funds||7,100||6,900||7,400||8,200||7,900|
Source: HMRC PEN 6 February 2018
One thing is immediately noticeable: the cost of employer pension contributions to personal pensions is steadily increasing.
In 2016/17, it rose by a sizeable 19 per cent from £4.3bn to £5.1bn, likely in response to auto-enrolment. According to the Pensions Regulator, the number of automatically enrolled employees increased from 5.2 million in 2015 to 6.1 million by 2016 and 7.7 million by 2017.
But there has not been a corresponding increase in the cost of tax relief on employee contributions to personal pensions. Instead, it has plateaued. This could be evidence the various tax relief tweaks are finally stalling individuals’ desire to contribute to their pensions.
Over recent years, several moves have put people off paying high amounts into pensions. The lifetime allowance has fallen yet again to £1.25m and now to £1m (although it will creep up ever so slightly to £1.03m from 6 April). But it is the introduction of two annual allowances that has created the most havoc.
The money purchase annual allowance was brought in to stop recycling of pensions by preventing anyone who had flexibly accessed their funds from paying more than £10,000 into one (although that has now dropped to £4,000).
However, it is the tapered annual allowance that has probably had a bigger impact.
Brought in for the 2016/17 tax year, it reduces the annual allowance to a minimum of £10,000 for people earning more than £150,000. Already, this has had a big effect on pension contributions, with many higher earners keen to establish exactly how much they earn in a year before paying in.
But it is not always clear cut and there is an abundance of anecdotal evidence of individuals using carry forward of unused annual allowance to mop up excess contributions or paying an annual allowance charge where they have exceeded their tapered annual allowance.
With a further cut in tapered annual allowance always threatening, it will be interesting to see whether this trend continues next year, especially as auto-enrolment contributions will increase to 3 per cent for employees.
The situation for occupational pension schemes is just as muddy. Again, there is no visible change in the cost year on year. However, a significant proportion of employers’ pension contributions go to plug scheme funding deficits, so it is hard to decipher exactly the effect of auto-enrolment and the future direction for the cost of pensions tax relief.
These statistics are valuable but they are one of many sources helping us decide if current pension policy is working and whether it passes the litmus test of encouraging more people to save more towards their retirement.
Rachel Vahey is product technical manager at Nucleus Financial