In recent years pension tax relief has been systematically reduced. Both the Lifetime Allowance (the effective cap of the tax benefits of using pensions) and the Annual Allowance (the tax efficient cap on contributions every year) have been severely restricted. The former peaked at £1.8 million in 2010/11, but currently sits at £1.03 million. The latter is currently at an absolute maximum of £40,000 with further income based restrictions. Pensions appear to be an easy tax revenue target for HMRC.
But things could get worse; the influential Treasury Select Committee has recommended abandoning the current system altogether, scrapping the Lifetime Allowance and introducing a lower Annual Allowance with a flat rate of tax. Explaining that; “Tax relief is not an effective or well-targeted way of incentivising saving into pensions and cost the Exchequer £41bn in 2016/17, according to HM Revenue & Customs estimates.”
The intention is to be fairer and to encourage people to save towards retirement, which seems a little counterproductive considering the reduced allowance and a focus on lost tax revenue.
What’s driven this?
According to HMRC’s Automatic Enrolment Review, around 12 million people in the UK are not saving enough towards their retirement. Research from Aegon has found that in order to provide a modest income equivalent to £28,000 a year from age 65, including state pension income, you would need a pension fund of over £610,000, or around 60% of the current Lifetime Allowance.
Widely reported in the media as a ‘Robin Hood Tax’, the proposed system would benefit lower earners and penalise higher, but ultimately raise greater tax revenue for HMRC.
Nicky Morgan, chair of the committee, explained that: “Many households are facing challenges that are putting pressure on the health and sustainability of their finances. Over-indebtedness, lack of rainy day savings and insufficient pension savings are some of the weaknesses in the household balance sheet identified in this inquiry.” But is attempting to address the issue at the cost of others fairer, as they intend?
Pension planning as we know it
As a recommendation, to date this is not Government policy. Planning within the context of current allowances still requires careful consideration. The existing £1.03 million Lifetime Allowance can be exceeded quicker than you realise. After all, we have experienced a nine-year bull run in the markets; a pension fund of £700,000 for a professional still in employment could easily exceed the allowance with modest growth. If surpassed, you will be liable to a tax of:
- 25% of any amount over the Lifetime Allowance taken as regular income
- 55% of any amount taken as a lump sum
Having a pension approaching or exceeding the Lifetime Allowance doesn’t mean your retirement planning should stop. In fact, if you are in employment, exceeding it might be the best option, assuming you are receiving matched employer pension contributions. The benefit of these contributions in this circumstance may still outweigh tax liability.
The existing Annual Allowance also requires considered planning, as it is currently subject to tapering for high earners, which means a reduction of up to £30,000. If you are earning an adjusted income over £150,000 and a threshold income of over £110,000, you will be subject to tapering: For every £2 of income over £150,000, your annual allowance will be reduced by £1, up to a £30,000 reduction. Therefore, anyone with an adjusted income of £210,000 or more will have an annual allowance of just £10,000.
The definitions of adjusted and threshold income are a little complex, but ultimately these income thresholds can have a significant impact on your retirement planning. There is a small saving grace within the current rules called Carry Forward, which permits you to utilise unused allowances from previous years. If this planning opportunity could be of value to you, talk to one of our financial planners.
The future of planning?
In reality, the likelihood of the Treasury Select Committee’s proposal coming into effect anytime soon is slim, but, it’s important to acknowledge the conclusion a group of cross-party MPs came to. More pressing matters such as Brexit negotiations will surely be Government’s priority over entertaining a pension legislation overhaul. That said, we have witnessed that existing allowances are prone to change dramatically, often to boost taxation. The future could be unpredictable; make use of the current legislation whilst we know it.