Helen Morrissey takes a look at recent changes to pension tax relief and examines who will be the main beneficiaries.
When details of pension tax relief changes were announced in October they were met with almost universal praise.
In the run up to the announcement, the industry had been awash with speculation that the changes would be overly restrictive and could act as a further disincentive to pension saving. One industry spokesperson even said the Treasury would be the only real beneficiaries at the expense of advisers and their clients. The changes were actually much better than many were expecting. Whereas the consultation document had spoken of reducing the £255,000 annual allowance to somewhere between £30,000 and £40,000 the actual figure now stands at £50,000 per year.
These contributions are subject to a three-year carry forward regime whereby any unused allowances in the past three tax years can be invested into a pension scheme. High earners will continue to be paid tax relief on pension savings at the highest rate at which they pay income tax.
Finally, the lifetime allowance was reduced from its current level of £1.8m to £1.5m. It is thought these changes will generate £4bn a year for the Treasury and could affect 100,000 pension savers a year – of which 80% have incomes of more than £100,000 a year.
Positivity within the industry
So given that these changes have actually resulted in a reduction in the amounts of money many people can put into a pension, why has the industry been so positive about the changes? To begin with there is certainly a sense that the situation could have been much worse. In addition many in the industry felt the government genuinely listened to industry concerns before making final decisions.
“You can look at the situation in two ways,” said AJ Bell’s marketing director, Billy Mackay. “The old rules used to allow contributions of up to £255,000 and a £1.8m lifetime allowance – we now have had these limits substantially reduced but we do live in a fiscally challenged environment. I think all things considered we have had a positive set of results. I feel the government has actually listened to the industry and taken on our point of view.”
He is joined by Hargreaves Lansdown’s head of pensions research Tom McPhail who added: “The government did as much as it could do. I was expecting them to cap the tax relief which would have caused problems. I feel as it stands the treasury has played a deft hand in keeping marginal rate tax relief, three-year carry forward and raising the allowance to £50,000.”
How has this improved the situation?
While annual allowances have been slashed it is important to look at the bigger picture. To begin with, the average person is unlikely to make contributions in the region of £50,000 a year so they will remain unaffected by these changes.
The real benefits come for more high net worth clients who now face a demonstrably clearer regime than had been in place previously. In early 2009 the Labour government cut pension tax relief for those earning £150,000 per year. This relief was tapered, meaning that those earning £180,000 would only receive 20% tax relief from April 2011. In addition to this, the government announced it would penalise anyone who made ‘irregular’ pension contributions of more than £30,000 a year with a 20% tax. The term ‘irregular’ also applied to pension transfers meaning higher earners lost a great deal of their pension flexibility.
The situation was worsened in December 2009 when the limit was dropped to those earning £130,000 or more who were effectively limited to making £20,000 contributions to their pensions per year. The changes announced in October are giving many clients a new level of flexibility in planning their pensions.
“What we have now is a good alternative for the complex system that had previously been put in place,” said Mackay. “It’s really brought the whole concept of pension and tax planning back into the picture. The fact you can carry forward contributions means I think we will start to see more people planning their pension contributions ahead.
“Part of the problem was the lack of uncertainty that we had around pension planning. People wondered what the incentive was to put money into a pension as the tax rules were all over the place. Now they know where they stand and they know how much they can contribute.”
Carry forward rule
So it is clear that the Treasury benefits from these changes to the tune of £4bn a year and that pension savers benefit from the increased flexibility. However, the changes present further opportunities for both clients and also their advisers according to Suffolk Life’s marketing director, John Moret, who believes advisers should have already begun highlighting which clients are in need of advice.
“Advisers need to do what they can now to prepare in advance for the changes,” he said. “The initial suggestions put the annual allowance at somewhere around £40,000 so advisers should have been going through their client bases to see who might be in need of further advice.”
One key area where opportunities for advice can occur is with regard to the three-year carry forward rule. This will enable those clients who had contributions restricted to make further contributions to their scheme.
“If we look at the end of the last tax year we had a lot of £20,000 contributions made by those who were affected by anti forestalling rules,” said Mackay. “If they can now go up and mop up the excess contributions as part of their £50,000 limit then that has to be good news.”
Under these rules there are also the opportunities for those who have not made contributions for the last few years to make a bumper contribution of £200,000 in the next tax year as they contribute for that tax year plus the previous three.
Another area where the adviser can offer real value is for clients due to retire in the next year. Under previous rule there was no limit on pension contributions in the year of vesting – advisers would do well to highlight this opportunity before it potentially disappears in the next tax year.
Suffolk Life’s Moret said: “If you have a client who is preparing to wind up their business for instance, and if it can be done before 6 April, they can take advantage of the rule that there is no annual limit in the year of vesting to get full tax relief. Checking the draft legislation this change comes in on 6 April 2011 so there is still time. Also, what would happen if someone was made redundant before 6 April? There is a chance they could take advantage of this too to put a large payment into their pension. If we look at the time immediately after A-Day there were several cases where six-figure contributions in excess of £225,000 were made so it is something people would want to take advantage of.”
Issues to consider
However, while there are several benefits to the changes there are also issues that need to be considered.
“The only disappointment was that they didn’t scrap pension input periods (PIP),” said McPhail. “This causes problems where the PIP ends in a subsequent tax year and all contributions are deemed to have landed in that tax year rather than spread across the two. The three-year carry forward rule will help to some extent but those who change jobs or run more than one pension could run into problems.”
Another issue that will need to be considered is how clients who have already accrued an overall pension pot in excess of the £1.5m lifetime allowance will be treated. Standard Life’s senior pension policy manager Andrew Tully expects these people will not be unfairly dealt with.
“The government will consult on those who are already in excess of the £1.5m allowance – perhaps they will allow them to keep the £1.8m but not contribute any more to their scheme,” he said. “It will be like the whole concept of enhanced protection that we had post A-Day as you don’t want to unfairly penalise those who have saved. You may also find that they will keep the LTA for the next few years after which it will eventually be phased out.”
Moret agreed that the lifetime allowance could cause problems and questioned whether it should remain in place at all.
“I know these changes have been driven by the intention of reducing the tax burden, but why have a lifetime allowance of £1.5m?” He added: “If you contribute £50,000 for 30 years then you have used this allowance up and we get to a point where you are taxing investment growth. These changes were a real opportunity to make life easier and they have gone some way towards doing that. But to keep the lifetime allowance – it is almost a stealth tax and it flies in the face of increasing longevity.”
However, according to St James’s Place head of pensions Ian Price the potential tax take of keeping the lifetime allowance in place means it is unlikely to be phased out any time soon.
So it would seem these changes bring opportunities for several groups of people. Where the Treasury benefits from its extra tax take, clients benefit from increased flexibility and advisers are given a real opportunity to re-engage with their client base. Most importantly, the changes could have the extra benefit of helping clients re-engage with their pension planning.
“We could well see pensions being used in the same way as ISAs in that they have a definite allowance each year,” said McPhail. “This could result in more engagement in pension planning.” A winning solution all round!
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