What does the Budget have in store for pensions?

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Chancellor George Osborne is capable of throwing the element of surprise into his Budget announcements. With this in mind, what lies in store for pensions in the emergency Budget on 8 July – the first fully Conservative Budget since 1996 – may not be easy to predict.

“Trying to second-guess the Chancellor is difficult but in terms of announcements specifically related to the pensions sector we can probably expect a few a notable mentions,” says Later Life Academy managing partner Stuart Wilson.

Tax relief for high earners

Many commentators are predicting cuts in pension tax relief for high earners. The Conservative Party manifesto included proposals to reduce tax relief on a sliding scale on pension contributions for people earning more than £150,000 a year: the threshold at which they become 45 per cent taxpayers.

With Budget Day looming – and knowing the Government could opt for speedy implementation of its proposals rather than waiting until the new tax year – pension advisers and providers have been urging high earners to make maximum use of the current tax reliefs now in case they disappear.

Thomas Miller Investments private client partner Matt Brown says reduced pensions tax relief for high earners will pay for plans to increase the inheritance tax threshold on main family homes. He points to two ideas for reducing pensions tax relief that came out of the Coalition government: a flat rate for everyone of 20 to 30 per cent or a reduction in the annual allowance.

Premier Pensions Management sales and marketing director Ian Gutteridge is not a fan of flat rate pensions tax relief of 20 to 30 per cent. “It wipes out tax planning for anyone who pays a higher rate of tax,” he says. Commentators are also concerned about the impact a flat rate would have on the funding of defined benefit schemes.

Given that flat rate tax relief was former pensions minister Steve Webb’s idea, and that the Conservatives wanted to distance themselves from the Liberal Democrats in their manifesto, Brown thinks it more likely the annual allowance will fall by £1 for every £2 an individual earns over £150,000, subject to a minimum annual allowance of £10,000.

“My personal preference is for Steve Webb’s idea, as it is easy to administer and understand. Anything that involves tapering is only going to cause complications,” he says.

Figures from Brewin Dolphin show that, under the Conservative proposals, the annual allowance would halve for someone earning £190,000, while someone earning £210,000 and over would have the £10,000 minimum. People earning £250,000 a year would see tax relief on their maximum pension contributions fall from £18,000 to £4,500 under the proposals, because their annual allowance would drop from £40,000 to £10,000.

According to JLT Employee Benefits chief actuary Hugh Nolan if the Government wants to tackle tax relief for high earners, now is politically a good time, as those affected would have a few years to forget about it before the next general election.

“My favourite stat is that the top 10 per cent of the highest earners receive 47 per cent of the tax relief on pension contributions. That is dramatically unfair. As a society, it is incumbent on us to ensure the poorest people struggling to make ends meet are encouraged to save in a pension: they need an incentive,” he says.

Nolan adds that if there is no incentive for high earners to save into pensions, there is a concern they will start buying properties instead and drive up prices. However, he recognises these fears may be overdone considering senior executives are often in special pension schemes.

Menzies senior tax manager Tim Humphries thinks a reduction in the annual allowance will cause problems for people like the self-employed, who will have no idea if they are going to breach it or not until the end of the tax year.

“It will put a lot of pressure on end of tax year planning and people will be advised to make contributions at the last minute,” he says.

Expanding on this point, St James’s Place divisional director, pensions and consultancy, Ian Price points out that income can come from a variety of sources and people will not know until the end of the tax year whether they have been affected by the tapering of relief or not.

“People can get caught out by tipping over without knowing it. Some years they will be impacted and some years they won’t be. That is another complexity,” he says.

According to Close Brothers Asset Management head of advice Andy Cumming if the Treasury restricts contributions for higher earners, it is likely to muddy the waters for salary sacrifice.

Salary sacrifice

Salary sacrifice is a way of saving into a pension where employees give up part of their salary and the employer pays this amount into the pension alongside their contribution. Employers and employees pay lower National Insurance Contributions because the salary is lower, and employers may choose to pay some or all or their NIC saving to the employee’s pension.

Aegon regulatory strategy manager Kate Smith says the Government could review salary sacrifice or scrap it altogether.

“Salary sacrifice is important for auto-enrolment, as employers can use it to manage costs or they can share their NIC savings with employees. It is hideously complex just now,” she says.

Cumming says that when changes to salary sacrifice were previously attempted, the pension and tax industry tied itself in knots trying to navigate who was and was not affected.

“We are likely to see a repeat of this if we do see another change. For instance, how would you differentiate between a company employee who had been sacrificing his salary for 10 years and a new recruit who has negotiated a much lower salary but much higher pension contribution?”

Nolan says if it was that easy to make changes to salary sacrifice, it would have been done already. “It is hard to do in practice. It would go down like a lead balloon and it affects everyone in the same way,” he says.

However, he points out that as salary sacrifice involves the employer paying less in NIC, the argument that could be used to justify changes is that everyone should pay their fair share.

Topping the wish list

Industry commentators are unanimous in begging for no more changes to pensions in this Budget but they do not expect it to happen.

Kirsty Worgan, ‎business development EMEA at Bravura Solutions, says: “I think there will be changes as the Government has made some pledges and needs to balance the books. It could put tax relief down to 20 per cent but I would prefer not to see anything happen because it makes things complicated for advisers who have to explain the changes to their clients.

“There is a lack of understanding when different changes come in and that leads to mistrust. We need to build up confidence in pensions and see how the freedoms have really impacted. I don’t like this constant chipping away at things,” she says.

Scrapping the lifetime allowance, which falls from £1.25m to £1m next year, would also be a popular move within the industry.

“The lifetime allowance seems to put people off and puts more pressure on the state,” says Humphries. “If you can save up to £1m in a pension, it would only buy you an income of £20,000 a year with an annuity. For significant earners that is not sufficient.”

“If we get rid of the lifetime allowance it would be more straightforward. You do away with the need for protection for those who already have assets over £1m. It’s easier to understand and people are less likely to fall into bear traps,” says Smith.

“A lifetime limit of £1m will have a bigger impact than people realise,” says Price. “If you have a limit on contributions, why do you need a lifetime limit? You are restricting the amount that goes in and potentially out at the other end. It will catch more and more people out over time.”

What is on the pensions industry’s wish list?

  • A period of consolidation, with no more drastic changes
  • Abolition of lifetime allowance
  • Doubling of Isa allowance to make up for reduction in annual allowance
  • Removal of salary requirements to qualify for auto-enrolment
  • Raising threshold for ‘benefits in kind’ tax liability when employer pays for employees’ financial advice from £150 to £1,000
  • Introduction of ‘pot follows member’ or a UK version of Australia’s Choice system
  • Abolition of National Insurance contributions