Pensions tax relief is cut again to save £1bn a year

Piggy bank

The government is cutting the tax relief it allows on people's contributions to company or private pension schemes.

George Osborne said his measure would save £1bn a year by 2016-17, out of the £6.6bn that individuals currently gain.

There will be two changes.

The lifetime allowance for pension savings will be cut from £1.5m to £1.25m in April 2014, and the annual allowance will be cut from £50,000 a year to £40,000.

The lifetime allowance is the maximum amount anyone can accrue in a pension pot while they are saving, and the annual allowance is the maximum that can be saved in any one year.

Savings accrued above these limits in pension funds not illegal, but are taxed.

The reduced allowances are one of the biggest savings in the autumn statement.

Only 1% of all people saving into pension schemes will be affected, the chancellor predicted, styling the cut as a way in which the wealthiest in society could contribute to plugging the government's spending deficit.

There was an immediate negative reaction from many in the pensions industry.

Joanne Segars, chief executive of the National Association of Pensions Funds (NAPF) said it was an example of meddling that would destabilise pension saving.

"The chancellor is wrong to say that the changes will only affect those at the top of the wage tree. Middle managers in the public and private sectors will get caught in the net.

Pension tax relief: the basics

  • The government gives tax relief on pension contributions
  • So for every pound you pay into a pension scheme, your taxable income is also reduced by one pound
  • Thus, if you are basic rate taxpayer, you save 20p in tax for every pound you make in pension contributions
  • If you are a higher rate taxpayer, you save 40p in tax for every pound you contribute
  • If you are an additional rate taxpayer, you save 50p in tax for every pound you contribute
  • In company pension schemes all this takes place automatically
  • Personal pension savers pay full tax on their contributions; then they or the firms they save with claim it back from the Revenue
  • Currently all this costs the government £6.6bn a year in lost income tax

"People in a final salary pension who have worked loyally for the same employer for years and then get a pay rise, or a promotion, could end up with a tax bill of several thousand pounds.

"The self-employed and those nearing retirement desperately trying to 'catch up' by boosting their pension are also at risk," she added.

Tom McPhail of investment firm Hargreaves Lansdown, echoed her views.

"Every time a chancellor tinkers with the rules governing our pensions, they undermine investors' confidence in saving for their retirement," he said.

"Today's announcement is robbing our future prosperity in order to bail out the costs of past government mistakes."

Gary Richards, a tax partner at law firm Berwin Leighton Paisner, predicted that some people would simply dodge the new, less generous, allowances.

"The lower pension threshold... is delayed to 2014-15 and may simply cause the most experienced public sector workers to retire early rather than hit wealthy tax payers who will divert their money into other assets," he said.

Pension schemes explained

  • Final-salary scheme: Guaranteed pension based on earnings at the end of your career and length of service
  • Career average scheme: Guaranteed pension based on your average pay over your career
  • Defined contribution scheme: Determined by contributions and investment returns. Usually worth less than final-salary pensions

But Andrew Tully, of pension firm MGM Advantage, said some transitional protection would be put in place, for those who were afraid they might be hit by the new, lower, lifetime allowance.

"Individuals who apply for fixed protection 2014 will be able to retain a lifetime allowance of £1.5 million, provided that from April 2014, if they are in a defined contribution scheme, no further pension contributions are made [and] if they are in a defined benefit scheme, they stop building up benefits above what is known as a 'relevant percentage'."

"This broadly allows benefits built up before April 2014 to be increased at a rate specified in scheme rules for the revaluation of accrued rights, or increase in line with consumer prices index (CPI)," he explained.

The government said that by 2015-16 it would still be granting £35bn in pension tax relief to pension savers, up from the current level of £31bn.

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