SHOULD you be pouring as much money as you can into your pension before tax relief, which is worth £34bn a year, is abolished or significantly cut, Ruth Emery of the Sunday Times reports.
A change to the generous system, which particularly rewards the well-paid, is widely expected. The chancellor launched a consultation in July — and the answer may be given in his autumn statement on November 25.
With a pensions minister who in her previous career championed a shift away from tax relief that favours the wealthy, and a chancellor who needs to save money, a change may well lie ahead.
Higher Rate Taxpayers receive 40% relief — in essence, free money from the government to encourage them to save for retirement — on their pension contributions. Basic-rate taxpayers receive 20% and those who earn more than £150,000 gain the most at 45%.
The Treasury consultation, due to finish at the end of this month, is looking at how to make the system simpler and, crucially, more sustainable and less expensive.
The tax relief bill has ballooned from £17.6bn in 2001-2 to £34.3bn in 2013-14. It could top £40bn by 2018, according to the pensions consultancy Hymans Robertson.
The government said it was “approaching the consultation with an open mind”, which could mean anything from the scrapping of tax relief to the introduction of a flat rate or of a ‘pension Isa’.
Steve Webb, the Liberal Democrat who served as pensions minister in the last government, has pushed for a 33% flat rate. In an article in Money last month, he said the “advantages would be considerable”.
His successor, Baroness Altmann, was previously an independent — and outspoken — pensions expert. In that role, she argued that a flat rate would be fairer.
People earning more than £110,000 could be hit by a clampdown already planned for April (see below).
How does tax relief work?
Everyone up to the age of 74, including children and non-taxpayers, can claim tax relief. The rate is 20% for children, those who do not pay tax and basic-rate taxpayers. If they paid £400 into a pension, an extra £100 would be added to their pot courtesy of HM Revenue & Customs.
The top-up is, substantially greater for higher earners. A £10,000 contribution would cost an additional-rate taxpayer only £5,500, for example.
Remember, though, that to benefit from the relief, your earnings must exceed your contributions — you cannot pay in more than you earn in a particular financial year.
If you do not pay income tax, you are given an allowance that means the first £2,880 put into a pension attracts tax relief. At the 20% rate, the contribution adds up to £3,600.
George Osborne emphasised in his budget that any changes would need “careful and public consideration”. Indeed, the Treasury consultation states: “The consensus may be that no change is needed.” But the pensions industry is expecting reform.
Many people find today’s system confusing, which is why a move to a 33% flat rate — which could be promoted as a supermarket-style deal: “Put £2 into your pension, get £1 free!” — would appeal.
Mike Currie at Fidelity Personal Investing said: “It is possible that in a few years, tax relief could be thought of like final salary schemes are today: a very generous offering for the ‘lucky few’ who happened to be at the right place at the right time.”
High earners currently get a fantastic deal thanks to their 40% or 45% rate. When they reach the age of 55, they can withdraw 25% of their pot tax-free, and pay income tax on the rest, meaning the government should recoup some of the relief it paid out. However, most people become basic-rate taxpayers in retirement as their income falls, so they pay just 20% tax on pension withdrawals.
This is one of the ways the system favours wealthy savers. More than two-thirds of pensions tax relief goes to higher and additional-rate taxpayers, according to the Treasury.
As Patrick Connolly at Chase de Vere puts it: “It is pretty certain that any new regime will not be more beneficial for higher or additional-rate taxpayers. For them, the situation will be the same, or it will be worse. It therefore makes sense to maximise pension contributions now.”
Should I borrow money to top up my pot?
We warn against such a move because of the cost of borrowing, the fact that the pension investments could fall in value, and the possibility that the chancellor may decide not to reform tax relief.
“There is the risk of ending up with some pretty expensive egg on your face,” said Connolly.
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