Pensions tax relief and the self-employed

Money Talk by Ronnie Ludwig
Saffery Champness

Image caption,
Millions of taxpayers may now have to watch the value of their pension pots very carefully each year

At the heart of the Treasury's recent pension proposals is a drastic reduction in the annual allowance qualifying for tax relief.

This could drop from the current £255,000 (for the 2010-11 tax year) to between £30,000 and £45,000 a year.

The practical impact is that many more people than at present may have to pay an extra tax bill each year if they wish to increase the value of their pension pots, since those exceeding the annual allowance will suffer a tax charge on the excess.

And for some, especially the self-employed with highly variable incomes, this could seem particularly unfair.


The need to restrict pensions tax relief in order to fill the black hole in public finances is understandable; higher taxes are inevitable as Britain's economy struggles back to health.

A reduced annual limit for pension contributions attracting higher rate tax relief may look simple and elegant. It is a way for the government to raise the billions in extra tax that the previous Labour government was hoping to raise by taxing the pension contributions of high earners only.

However the recently proposed plan of the coalition is based on the model of regular income and regular pension contributions.

That means it would effectively discriminate against the self-employed or small business owners whose income patterns are more uneven.

Lumpy incomes

As the millions of self-employed workers know all too well, their incomes differ year on year.

Their businesses are subject to market fluctuations, dips in consumer confidence or even seasonal variations.

They simply cannot rely on a stable salary from which to make regular annual payments into their pension plan.

They might have several lean years where they simply cannot afford to put any money into a pension and then have a fantastic year.

Obvious examples are the self-employed who do not run their businesses as a limited company, and those in partnership.

One of the most affected groups is likely to be farmers, whose fortunes fluctuate greatly from year to year depending upon not only grain price fluctuations, but that most unreliable element, the weather.

A lower annual limit would restrict the pension contributions they could make in a good year, making it difficult to catch up for previous years when they had not been doing so well.

Simple change

There is no facility for the self-employed with lumpy incomes to play catch-up when they have a good year following several bad ones.

This is because their earnings for pension purposes are the same as the profits stated in their annual accounts; what they actually draw from the business as income is irrelevant.

A possible solution may be for them to consider incorporating and becoming a limited company.

Then, the pension contributions would be calculated on the salary they in fact paid themselves and not on the profitability of the business.

However this could be a costly way around a problem which is capable of being easily fixed by a simple change in the legislation.

The tax authorities could instead allow a "clawback period" of, say, five years, so that you could catch up for the last five years when you could not afford to pay anything.


The proposed changes will not just affect the self-employed.

Image caption,
The new plans could be an unexpected burden for some, says Ronnie Ludwig

Employees are also likely to be adversely affected by the pension tax relief proposals and so, in the future, will be people who are currently students.

They are now typically burdened by record amounts of debt upon graduating, and few would be able to make significant regular pension contributions from the start of their working life.

Yet, there appears to be no provision to help them catch up later in their working life, when they are able to save more for retirement.

Most people accept that higher taxes are going to be inevitable as Britain strives to restore its public sector finances back to health.

But greater consideration of the financial pressures on business owners or even young employees would be welcome before the reforms to the tax system are implemented.

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