Budget 2016: What will the chancellor do to pensions?
It is less than a year since the government launched what came to be known as the pension "freedoms" - the right for those over 55 to take as much money as they like from their pension pots, subject to tax.
Now, ahead of the budget on 16 March, the pensions industry is again on the edge of its seat.
Amongst the rumours: The chancellor is about to abolish the 25% tax-free lump sum; the maximum annual contribution could be cut to as low as £25,000; or the whole tax relief system could be abolished, in favour of an Isa-style system of tax upfront, but tax free on the way out.
So what are the chancellor's options - and which is he likely to favour?
Flat-rate relief on contributions
At the moment, basic rate taxpayers who pay into a pension get 20% tax relief. Higher rate taxpayers get 40% - and top rate taxpayers get 45%.
But higher rate tax relief costs the Treasury some £7bn a year, and clearly favours the well-off.
Replacing this with flat-rate relief would be beneficial to most workers, AND save the government money.
The lower the figure is set, the better off the Treasury would be, but the smaller the benefit to savers. Options being talked about are 25%, 30%, 33% or, if the chancellor was in generous mood, even 35%.
But, as has been pointed out vehemently by the pensions industry, higher and top rate taxpayers stand to lose.
The Association of British Insurers (ABI) has lobbied hard for this solution, calling it a "savers' bonus". But The Pensions and Lifetime Savings Association (PLSA) has said it would produce little benefit to basic rate taxpayers, especially if set at 25%.
Winners and Losers
Clearly basic rate taxpayers would gain from a flat rate of tax relief, while higher and top rate taxpayers would lose out.
But even under the current system, calculating tax relief is a complex matter.
Suppose John, a basic rate taxpayer, wants to contribute £8,000 into his pension. To earn that sum, he would have been paid £10,000 gross - ie before tax. The difference - £2000 - is what he gets back in tax relief. £2000 is 20% of the gross, or pre-tax, amount.
If John were a 40% taxpayer he would need to make only a £6,000 net payment for a gross contribution of £10,000. His tax relief would be £4,000.
The table below provides an indication of how much John would stand to win or lose if we changed to a flat rate system.
Top rate taxpayers (45%) stand to lose even more.
|Winners and Losers : How flat-rate tax relief would affect a gross pension contribution of £10,000|
|Basic rate taxpayer||40% taxpayer (higher rate)|
|Current tax relief||£2,000||£4,000|
|25% flat rate relief||£2,500||£2,500|
|30% flat rate relief||£3,000||£3,000|
|33% flat rate relief||£3,300||£3,300|
|Source: Hargreaves Lansdown|
One idea the Treasury has examined is to make pensions like Individual Savings Accounts, or Isas.
Pension savers currently pay no tax on money they put into a pension, but they do pay tax on the money they take out.
An Isa system would be the opposite: Income tax would be paid before the money was saved, but it would be tax-free when taken out.
If this was chosen, the current 25% tax-free lump sum would also disappear.
The huge advantage to this from the Treasury's point of view is that the government would immediately save billions of pounds in up-front tax relief.
But to run an Isa system alongside the current system would be horribly complex.
And there would be no immediate incentive to encourage people to save more, as the tax benefits would only occur after they had retired.
While the former pensions minister, Steve Webb, thinks this option is still a strong possibility, in practice it is unlikely.
The amount anyone can save into a pension - and get tax relief - is already capped in two regards:
- Annual Allowance: £40,000. However from 6 April, top-rate taxpayers will see this reduced by £1 for every £2 they earn above £150,000.
- Lifetime Allowance: Currently £1.25m, but from 6 April this will be cut to £1m.
Cutting these limits further would save the Treasury more money.
Tom McPhail, pensions expert with Hargreaves Lansdown, thinks a reduction to the Annual Allowance is "highly likely, possibly down to as low as £25,000".
But reducing it would be difficult for savers who make large contributions near retirement, to catch up on earlier under-funding.
As for the Lifetime Allowance, Mr McPhail describes it as a "perverse irrelevance", but believes the government may be reluctant to give it up.
Abolishing salary sacrifice
Many employers offer their staff "salary sacrifice". Employees agree to take a smaller salary, in return for increased benefits, including pension contributions.
This can mean the employee pays less income tax, while the employer saves on National Insurance contributions.
This is widely seen as a loophole, which costs the Treasury a significant amount of revenue. The chancellor could well decide to abolish it, or place restrictions on the way it operates.
After an eight-month Treasury consultation - which has the potential to save the government money and improve fairness - it is unlikely the chancellor would choose this option.
"Incredulity meters would explode, jaws would drop and hats would be eaten," says Tom McPhail.
But equally well, the chancellor may decide not to do anything too radical. Last year's pension reforms are still bedding in, and the government's big idea of auto enrolment has a long way to go.
Many small employers, and workers, are struggling to understand those changes. The last thing they want - or the industry can stand - will be another upheaval of the pensions system.