So here we are, just over a month away from the Budget on 16 March and the one thing that is not a surprise is that the Chancellor will be announcing the results of the review of the tax system that applies to private pensions. We know this because he announced he would be announcing it then, in his Autumn Statement and Spending Review. He likes his announcements does Gideon?
Cue predictable press outrage especially from those papers that claim to speak for middle England, alleging that their readers are going to be betrayed (again) by the Government, in between its covering up Princess Di’s murder and not being beastly enough to our European neighbours.
A potentially contentious policy has been duly trailed and a reaction equally duly generated. So is it a case of the Government “flying kites” or are we seeing a softening up of those affected for what is ostensibly bad news – a barely disguised tax hike for the “squeezed middle”, which is, in effect, what the trailed changes will constitute.
So what can we expect? In Sean Browes’ recent blog “Pensions tax reform – is it time to Tee off?” he talked through the changes that moving from an E(xempt)E(xempt)T(axed) to a T(axed)E(xempt)E(exempt) basis would entail. This was one of the kites flown in the consultation, so we could reasonably expect to see some change here. The catchy mnemonic T+ET (Taxed, Topped Up, Exempt, Taxed) was recently mooted as where the Chancellor’s kite had eventually landed. We’ll soon see.
Another of the kites dancing across the patch of sky above 11 Downing Street that has generated comment is a move to a flat rate of pension tax relief for everyone. This has been so heavily trailed, as to be almost certain. Figures quoted for the flat rate are 25% or 30%. There is certainly a simple elegance in this but there will also be winners and losers. Apologies for the pensions 101, but under the present system pension contributions attract tax relief at the contributors marginal rate of tax. For the majority of earners, that’s 20 per cent relief. Higher rate tax payers receive 40 per cent relief and top-rate taxpayers (anyone who earns £150,000 or more) get 45 per cent relief. So it’s pretty clear that the winners will be those who currently pay 20%, and this will be paid for by those who will see their tax relief cut.
But why is there seen to be a need for change?
Well, let’s have a look at the Government’s own figures*.
The number of people paying at the 40% tax rate has increased
- 3.02 million people in 2010/11 – 9.65% of tax payers
- 4.65 million estimated in 2015/16 – 15.66% of tax payers
On top of that those paying the additional rate
- 332,000 estimated in 2015/16 – 1.1% of tax payers
The consequence of this is that over two thirds of pensions tax relief currently goes to higher and additional rate taxpayers. (Strengthening the incentive to save: HM Treasury 2015).
That perhaps explains, in part, the Government’s focus for change.
Aha, I hear you say, but we offer Salary Sacrifice, so all the contributions are paid as employer contributions and the member gets relief at their highest rate. All will be right in the higher rate tax payer world, thanks to this perfectly legitimate wheeze. Aha, you hear me say, but (there is always a but) if we can spot this then, guess what, so can the Treasury. It would be, frankly, plain daft for a loophole this huge to be left open. That’s why you would fully expect Salary Sacrifice to be changed, if not entirely removed, for pension scheme contributions in the Budget if we get a move to the flat rate of tax relief. We might even see employer contributions charged as a benefit in kind for the first time, although that may be a kite flight too far at this point.
So we have some known unknowns, that will soon be known knowns which will be added to some already known knowns, with apologies for the Rumsfeld speak (but it shall return).
Firstly, from 2016, the Lifetime Allowance will reduce to £1m from £1.25m.
Secondly, for tax year 2016/17 the annual allowance will be reduced (through tapering) for those with annual incomes over £150,000. For every £2 of income over £150,000, an individual’s annual allowance will be reduced by £1, down to a minimum of £10,000.
High earners need to be aware and consider what action they need to take.
What impact does this have for Trustees?
Once the known unknowns become known knowns, at the Budget, Trustees will need to analyse them and inform their members of what they now know. So trustees may be faced with explaining to members how a flat rate of tax relief will work depending on whether the scheme operates on a relief at source or net pay arrangement. If schemes use salary sacrifice then changes will need to factored in and explained. How should high earners react to any changes? Should they do anything in anticipation? Finally, how prepared are your administration providers? It is worth asking the question.
Mind you, it’s the unknown unknowns that can really trip you up. Michael Johnson of the Centre for Policy Studies recently told delegates at the True Potential Outlook and Opportunities Forum in Manchester that if the Chancellor is to scrap pensions tax relief within the decade then he will do it this March in the Budget. Whilst Michael has been banging this particular drum for some considerable time, the cumulative effect of the various kites aloft at present could point to him finally being right.
So roll on 16 March. Yet another significant day for pensions. How significant? That’s an unknown that will soon be known if you know what I mean.