Pensions tax relief: Will it be cut again?
The government's generosity towards people saving for their pensions may be restricted even more in this week's Autumn Statement.
It is widely believed that the coalition has pensions tax relief in its sights, again.
This is partly to save money and partly for political reasons.
The coalition, so it is said, wants to show that higher-paid workers are going to suffer under the government's continuing austerity programme, along with everyone else who depends, one way or another, on state spending.
Malcolm McLean, of the actuarial firm Barnett Waddingham, says any further cut in tax relief would go against the grain of government policy, which is trying to encourage more people to save for their pensions.
"This is a soft target for the chancellor but it's not a good idea in terms of the message it sends out," he says.
"You have one half of the government talking about reinvigorating pension saving, and introducing automatic enrolment to try to make sure people do save, and the other side hitting the pension system and the ability of people to contribute to a larger extent - it is a mixed message."
For their part, it has been official Liberal Democrat policy since 2006 to do away with pensions tax relief for higher-paid people, who are currently taxed at rates of 40% or even 50%.
The big idea that has been touted is that there should be a further cut in the current £50,000 annual allowance. This is the limit on how much people can put into their schemes each year while still gaining tax relief.
Last December the government published an estimate that a cut in this limit to £40,000 would save the Treasury £600m a year.
Another set of figures doing the rounds, from the Standard Life insurance company, suggests a deeper cut to £30,000 a year would save an estimated £1.8bn.
In the wider scheme of things, anything that saves or costs the exchequer more than a billion pounds a year is a quite a big deal.
So it is no surprise that this area of spending presents quite a juicy target.
In the 2010-11 tax year, the government "gave away" just under £33bn in tax relief to people saving in pension schemes.
It is worth noting that only a small proportion of this - just £6.6bn - went directly to individuals who were putting money into their company or personal pension schemes.
The vast bulk of the tax relief was in fact due to tax foregone because:
- employers do not pay tax on the pension contributions they make for their staff
- pension schemes do not pay tax on the income they receive from their investments
- employers do not pay National Insurance on the pension contributions they make.
How it works
The aim of tax relief is to encourage people to save in pension schemes so they will have an income, over and above the state pension, in their retirement.
The basic point is that if individuals put £1 into a company or personal pension fund, then £1 is knocked off their taxable income, saving them income tax in the process.
A basic-rate taxpayer saves 20p for every £1 they contribute to their pensions.
Higher-rate taxpayers save 40p for every pound they pay in.
And those paying the 50% additional tax rate, which is levied on taxable earnings over £150,000, save 50p for every pound of their pension contributions.
Cutting the generosity of pensions tax relief became an obsession for the last Labour government, which brought in some extraordinarily complicated laws to claw it back from the highest paid.
These new rules were promptly thrown out by the newly elected coalition government in 2010.
Instead, it decided that from 2011-12, the annual amount which someone could put into their pension pot (either through employee and employer contributions, or through the accrual of extra benefits in a final-salary scheme) would be drastically reduced from £255,000 a year, to £50,000 or the level of your annual salary, whichever is lower.
And from the 2012-13 tax year, the total value of anyone's accrued pension pot at retirement - the so-called lifetime allowance - has been reduced from £1.8m to £1.5m.
Anyone going above these new limits is taxed on the surplus in their pension funds.
The tax authorities estimated at the time that those two measures would save about £4bn a year in tax relief.
How much more?
The people who would suffer are those whose pension pots might rise by more than, say, £30,000 or £40,000 in any one year, depending on the precise level of any new lower limit.
Chas Roy-Chowdhury, of the ACCA accountancy body, says lower annual limits could easily affect people who are ordinary members of final-salary pension schemes, such as staff in the public sector.
"In general, the limit of the allowance is calculated in a final-salary scheme by multiplying the rise in someone's pension entitlement by a factor of 16," he says.
"So somebody earning, say, £50,000 a year who received a £5,000 pay rise from a promotion might easily find they have bumped up against a new lower limit or exceeded it," he says.
In a defined-contribution scheme the annual limit is the same, but the tax authorities simply add up how much has been put into a pension fund in any one year, while ignoring any investment profits or losses during the year.
John Whiting, of the Chartered Institute of Taxation (CIOT), says those who might be caught would be more numerous than just the very wealthy.
"One group might be the self-employed with very lumpy earnings from one year to the next, whose ability to make pension contributions fluctuates a lot from year to year," he says.
"Another might be women who have been out of the labour market raising families. They start working and earning again quite well, and start making substantial pension contributions."
In the calculations, some of any unused annual allowances from the previous three years can be carried forward, to offset a breach of the limit.
So the £50,000 limit is not as rigid as it seems.
An alternative restriction
There are alternative ways of restricting tax relief.
At the moment, people retiring can take 25% of their pension funds as lump sums in cash, tax-free, in return for smaller pensions. That lump sum could simply be reduced.
What about a superficially much simpler way of cutting the generosity of pension tax relief, by simply making it a 20p in the pound relief for all pension savers, regardless of their highest tax rate?
Previous government calculations have suggested this would save more than £2bn at a stroke.
But David Robbins, a pension consultant at actuaries Towers Watson, says it would bring with it lot of complications, and might not save as much money as expected.
"If are a 40% taxpayer, but were only getting 20% tax relief, you could simply go to your employer and ask them to cut your salary but put more by way of employer pension contributions into your scheme. Because employer contributions are not taxed, you would effectively get 40% relief on that money," he says.
"The only way to stop that would be to bring in a new tax on employer contributions, which would be very difficult."