Higher earners could face further cuts to valuable pension tax perks in Chancellor Philip Hammond’s November 2018 Budget following cross-party calls to limit tax breaks for the well-off.
A report published last month by the Treasury Committee of MPs concluded that the Government should “give serious consideration to introducing a flat rate of [tax] relief”, among other changes, some of which might also disadvantage higher earners.
Controversy over tax relief on pension contributions – which costs the Exchequer approximately £40 billion per year – last surfaced in a 2015 public consultation undertaken by the Treasury. No substantial changes were subsequently introduced, however. Now the issue has surfaced again as the public finances come under increased strain.
All Britain’s major political parties have indicated or stated a wish to curtail tax relief. The current system allows (within limits, see below) tax relief to apply to pension contributions at the saver’s highest marginal rate.
This proves extremely valuable, particularly as the rules allow a quarter of the eventual pension to be drawn free of further tax. Some wealthy savers are choosing not to draw their pensions at all but to bequeath them to their heirs – effectively deferring or reducing a tax liability even further.
“While we talk about the likelihood of future cuts to tax relief, we mustn’t overlook what’s already been done to limit tax reliefs in the form of falling allowances,” says James Gladstone, Head of Wealth Planning.
The annual allowance – the maximum anyone can invest in a pension per tax year – has fallen by more than 80% in under a decade. It stood at £255,000 in 2010 and is now £40,000.
The lifetime allowance – which caps the value of an individual’s pension fund over a lifetime – has dropped from £1.8 million in 2010 to £1.03 million in the current tax year.
The introduction by the Conservative Government in April 2016 of the tax relief “taper” – which scales back the £40,000 annual allowance where earnings exceed a set threshold – was a further blow.
As well as being extremely difficult to administer, it has resulted in significantly reduced contributions for some. The highest earners face a further maximum reduction of £30,000, giving an annual allowance of £10,000. In practice, many people in this bracket have limited their pension savings purely to avoid any possibility of miscalculating their permissible contributions.
Overall, the share of income tax relief paid to the very highest earners (those earning in excess of £500,000) has fallen 40% since 2010, according to research published by the Treasury Committee of MPs.
Higher earners with the ability to contribute one-off sums should consider doing so now as a precaution against reliefs and allowances being cut further.
“There is a possibility that any announced changes to the pension system may become effective immediately, which is why planning ahead would seem prudent,” said James Gladstone.
The primary way in which higher earners can add significantly to their pension funds is by carrying forward unused allowances from previous years. The unused allowances of the past three tax years are permitted to be “carried forward” in this way, but the interaction of the carry-forward rules and the taper rules complicates the process.
It is possible, however, that high earners who are limited by the taper in this tax year (2018-19) could still benefit from carrying forward unused allowance from the 2015-16 year - which was the final tax year in which the taper did not apply. For subsequent years unused allowance can be carried forward only subject to the taper.
A number of high-profile individuals and lobby groups from across the political spectrum have voiced support for a system where higher-rates of relief are replaced with a flat rate. This would represent a reduction in benefits for earners currently paying marginal rates of 40% or 45%.
The idea of reducing reliefs for higher earners also has general support from all of Britain’s major political parties.
There is no certainty that the upcoming Budget will usher in any changes. But over time it is likely that tax relief will be subject to further cuts.
“There is a growing consensus that pension tax relief is due for reform - and in most conceivable scenarios this will result in higher earners being worse off. Reducing the cost of tax relief is something that many chancellors have longed to do for many years. The least politically risky way of doing it is by further targeting big earners.”
There is another obstacle, however, which could deter governments from a significant overhaul: complexity. The existing system is already fiendishly complicated and to expose a wider group of people to the taper will be logistically challenging for all concerned, including HM Revenue & Customs.
James Gladstone, Head of Wealth Planning, said: “We have had a series of cuts to allowances and reliefs going back many years, some of which are still bedding in. The tapering of relief for those earning £150,000-plus is proving very challenging to manage, especially for those who have variable compensation arrangements. There are some very loud voices warning of the consequences of radical change in this area.”
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.