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Rip it up and start again

Head to head: Is the Government right to tear up the previous administration’s proposed restrictions to higher-rate tax relief in favour of a reduced annual allowance?

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Adrian Walker, Platform marketing manager, Skandia

The emergency Budget confirmed that the coalition Government is keen to avoid the complexity that surrounds the current proposals to restrict pension tax relief for those with income over £150,000. This is welcome news but there is a danger that the current alternative proposal to reduce the annual allowance on pension contributions will unduly limit the flexibility of saving for retirement.

The emergency Budget stated that the annual allowance would need to be in the range of £30,000 to £45,000 to result in the same level of cost savings to the Government as the current proposals.

Imposing this lower limit on annual pension contributions would have a fundamental impact on the reality of how a large number of people actually fund their pension. Many people make modest or no pension contributions in their early professional years and then make up for this with significant pension cont-ributions in later life when they have more excess income.

Imposing this lower limit on contributions would have a fundamental impact on how a large number of people fund their pension

To reach the current lifetime Imposing this lower limit on contributions would have a fundamental impact on how a large number of people fund their pensionallowance of £1.8m, someone would have to save £43,919 for 25 years, assuming an annual growth rate of 5 per cent. If they delayed this by five years, they would have to save £60,768 every year to reach the allowance. With the proposed cap on annual contributions, these people would never be able to make up the difference required to reach the lifetime allowance. The problem is even more pronounced for the majority of people who will not be able to make pension contributions anywhere near this size early in their professional years. Arguably, the Government could save costs by extending the lifetime allowance freeze for a further five years beyond 2016 or could even reduce the lifetime allowance to less than £1.8m if necessary. This would have the effect of reducing the annual pension contributions that many individuals will make while at the same time giving people the flexibility to make up shortfalls in pension funding when they can afford to do so.

If the Government does decide that a lower cap on annual pension contributions is necessary, it should at least be accompanied by the freedom to allow people to carry unused pension contributions forward for a rolling period of three years. This would not create additional cost for the Government because the maximum tax relief available would not increase but it would give people the freedom to benefit from tax relief on significant pension contributions in the years that they can afford to do so.

Whichever change is agreed, it must be simple and easy for consumers to understand. If this can be achieved, the changes could go a long way to encouraging more people to save via pensions.

Steve Bee, Managing pensions partner, Paradigm

One of the most interesting things to come out of the emergency Budget was HM Treasury’s paper on the possible pension tax reforms to come. Some of the possible reforms have centered around higher-rate tax relief and have meant there is lots of talk about how the tax relief “given” to higher-rate taxpayers “costs” us billions of pounds.

If we are not careful, we are all going to go along with an argument that says all tax relief on pensions, even tax relief at the basic rate, is “costing” us billions. If higher-rate tax relief is a cost, so is basic-rate tax relief. Indeed, the money that employers pay into pension schemes probably “costs” us billions too – maybe that needs looking into as well?

Pensions are good because the money you make and then put into them is EET. In fact, bits of pensions are EEE – which is as good as it gets. Isas are TEE, which Pensions are good because the money you make and put into them is EET. In fact, bits of pensions are EEE – which is as good as it getsis pretty good and certainly better than standard savings accounts that are TTE. Confused? I used to be really confused about this too until one day it just clicked and I worked out what was going on.

Pensions are good because the money you make and put into them is EET. In fact, bits of pensions are EEE – which is as good as it gets

EET turns out to be nothing more than a shorthand way of describing that contributions towards pensions are exempt from liability to tax and that the growth of the pension fund is similarly exempt (well, exempt-ish these days, anyway) but that the resulting annuity is taxed. So EET – Exempt, Exempt, Taxed. TEE, on the other hand, describes Isas where the money invested comes from taxed income but the fund grows in a tax-exempt environment and the ensuing benefit is exempt of tax liability too – Taxed, Exempt, Exempt.

Basically, the more Es you get in your three-letter mixture of Es and Ts, the better the deal from the tax guys. Also, the nearer they are to the front, the better. For instance, EET is better than TEE or, in plain English, pensions are better than Isas because you get tax-relief up-front and effectively invest more than you actually pay in.

On the other hand, the more Ts you get, the worse the deal. So, TTT wouldn’t be too attractive and that’s what bothers me about compulsion. The thing is, if we are ever compelled to save for our pensions in the UK in the way some people seem to think we ought to be, then why would the Government need to incentivise us to put money into pensions too? Tax relief is given at the moment to encourage people to put pension savings aside in our voluntary pensions system. If we ever look likely to end up with pension compulsion and the removal of the tax-incentives and end up with a TTT system on offer, it would not get my vote.

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  1. Jim Withenshaw 2nd July 2010 at 9:55 am

    “For instance, EET is better than TEE or, in plain English, pensions are better than Isas because you get tax-relief up-front and effectively invest more than you actually pay in.”

    No.

    The 25% tax-free lump sum and the possibility of being in a lower tax rate at retirement than when in work gives pensions the edge, effectively making the trailing tax rate on pension payments lower than the leading tax rate on Isa contributions.

    For a person who forgoes or cannot take the tax-free lump sum, and whose tax rate on pension payments in retirement is the same as their tax rate on Isa contributions while working, EET and TEE are precisely mathematically equivalent.

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