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Rachel Vahey: Pension tax relief tweaks start to bite

Rachel VaheyEvidence 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)

  2012/13 2013/14 2014/15 2015/16 2016/17
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
TOTAL 35,000 33,800 34,600 38,500 38,600

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.

Creating havoc

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


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There are 3 comments at the moment, we would love to hear your opinion too.

  1. I have been making the same comment for at least a year now whenever anyone has suggested that the way to reduce the “cost” of pensions tax relief would be to axe higher-rate tax relief and instead bring in a flat rate of 30%.
    The points I have made time and time again on various forums are that: the cost of higher-rate relief is a red herring due to the reductions in annual and lifetime allowances, and the introduction of tapered annual allowance; the cost of employer tax relief as a result of DB scheme funding and AE are the real problem; and the unintended consequence of a flat rate of relief at 30% would be to actually increase the cost of tax relief due to AE.
    These figures appear to validate all three arguments.

  2. Andrew Macintyre 28th March 2018 at 11:00 am

    The constant tinkering and moving of the goalposts will continue to turn people off pensions. That financial advice is necessary to avoid the many pitfalls, is just going to be a bigger turn-off for many people. Whatever happened to pensions simplification?

  3. Potentially the figures can be interpreted differently.

    The increase in employer contributions to Personal Pensions is likely to be due to a combination of factors. Some is no doubt to do with increasing AE contributions (although with many firms offering 1% matching on Qualifying Earnings, with this point the volume of staff undertaking this is large but the value is in proportion low).

    However, in my sphere business owners have, at least since “pension freedoms”, started to really appreciate the benefit of making pension contributions and due to effect of the salary / dividend mix on allowable personal contributions (and the other factors on dividends etc. below) have made during the last few years large employer contributions to their own pension arrangements. There are plenty of directors who restrict their earnings to keep the Personal Allowance, keep below £150k or avoid the taper.

    To my mind this is likely to account for a fair proportion of the uplift (as there doesn’t seem to be an similar uplift in employee payments). The more dividend payments are targeted the more attractive pension payments become.

    It takes 400 employees with a £16k salary (using QE Band earnings at 1% employer payment) to reach one £40k director payment in the period of the data.

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