Fears grow over pension tax relief and tax free lump sums

Posted on November 18th, 2011 | Categories - News

There are growing fears that Chancellor George Osborne is planning to make changes to pensions which could see a reduction in their tax efficiency.

It is understood that the Treasury are considering two options, which could see the tax relief on contributions for higher rate tax payers restricted or the amount of tax free lump sum allowed at retirement capped or reduced.

Pre budget statement

The Chancellor is due to deliver his pre budget statement on 29th November and it is thought by some experts that changes to the pension system are likely.

Reducing tax relief for higher rate tax payers would see huge immediate savings made and capping the amount of tax free lump sum available would see revenues rise through higher income tax bills for pensioners.

The government has recently come under pressure from Labour to scrap higher rate tax relief with Rachel Reeves, former shadow pension’s minister, saying that the government should look at ways of making the pensions system “more efficient, more effective and better value for the taxpayer”.

Pension tax free lump sums

Current rules allow anyone over the age of 55 to take up to 25% of their pension fund as a tax free lump sum.

Many people use the lump sum to repay debt, carry out home improvements or meet the cost of capital expenditure as they move into retirement. Given the current economic climate and falling Annuity rates, many people are simply saving the money for ‘a rainy day’ or using it to supplement their income, often buying a Purchased Life Annuity (PLA) or simply putting the money in a savings account and using the interest to help meet day to day living expenses.

Pension tax relief

Contributions, up to £50,000 per year, attract tax relief at the highest rate of tax paid, this is designed to encourage people to make pension contributions and plan for their retirement.

A 20% tax payer, for example, paying £80 per month into their pension would receive an additional £20 of tax relief. A higher rate taxpayer, paying 40%, would be able to claim back an additional £20, making the net cost of the £100 contribution just £60.

Higher rate tax relief is however thought by some people to be unfair and that basic rate tax relief is not enough of an incentive for the lower paid to save for their retirement.

Reaction

Both the financial community and people nearing retirement are likely to oppose any change to the pension system, particularly if the amount of tax free lump sum available is capped.

Experts point out that people have saved into pensions during their working lives in the expectation that 25% of the fund can be accessed as a tax free lump sum, many people have plans for this money, which they may not be able to see through if the amount available is reduced or scrapped.

At a time when the public’s confidence in the pensions system is low, a retrospective change to the tax free lump sum rules would be far from popular and do nothing to motivate people to make pension contributions and plan for their retirement.