One of the reasons many people pay into a pension is because of the tax-relief they receive.
The quid pro quo for this additional boost to your pension pot, is that you have to leave it invested until you hit 55 (later for some younger savers retiring after 2028), but this is generally accepted, especially after the recent introduction of Pensions Freedom.
However, with the election out of the way, and the Government searching for billions of pounds in savings, many people are predicting that tax-relief on pensions could be reformed.
So, what could change? What action should you take now?
Before we get to that though, a quick reminder, how does tax-relief work?
Pension tax-relief, a 30 second guide
It’s actually pretty simple.
For every £80 you pay into a pension the Government will pay in an extra £20, although there are a couple of restrictions you need to know about. For example, the maximum which can be paid into a pension is limited to your taxable earnings, or £40,000, whichever is lower. Furthermore, if you have no taxable income, you can still pay in £2,800 and get the tax-relief top up of £800.
That’s the long and short of it for basic rate taxpayers, as well as those people who pay no tax on their earnings.
Higher rate taxpayers, can claim an additional amount through their tax return.
So, to continue with the previous example, a 40% taxpayer can claim back an additional £20, taking the total personal outlay to £60, with £100 being credited to his or her pension. A 45% taxpayer can claim back even more, to take the net cost of a £100 contribution to just £55.
Tax-relief makes pensions attractive but is costing the Government billions; in the 2013 / 14 tax year the bill was just over £30 billion.
Given the huge numbers, and the fact higher rate tax-relief naturally goes to those people earning larger amounts, it really isn’t hard to see why it might be a target for the Government.
Is higher rate tax-relief going to be cut in the Budget on 8th July?
Quite possibly, in fact we would be very surprised if higher rate tax-relief wasn’t restricted in some way.
The Conservative election manifesto set out proposals for restricting the amount of higher rate tax-relief available for people earning over £150,000 per year. If the reforms are introduced as laid out in the manifesto, those people earning over £210,000 per year would only be able to pay £10,000 per year into their pension; just 25% of their current Annual Allowance.
There are 300,000 people or so earning more than £150,000, so such a change would affect a relatively small number of people. However, only time will tell whether the Government decides to go even further.
What other options does the Government have?
Successive Governments have long seen pensions as a piggy bank they can raid to raise revenue, the fear is that this trend will continue.
George Osborne has already announced in the Budget earlier this year that the Lifetime Allowance, the amount you can hold in your pension before you start to pay tax, will be cut to £1 million.
Given that this was only announced a few months ago, plus concern that it catches people on relatively modest earnings, we can probably rule out a further change to the Annual Allowance.
However, on top of the tax relief changes outlined in the Conservative manifesto, the Chancellor could decide to tinker with some of the more complex pension rules, such as Carry Forward and Pension Input Periods, which allow some people to make very large contributions.
There are also predictions that salary sacrifice, a way of arranging pension contributions which reduces the amount of National Insurance paid by employees and employers, could also be hit.
What steps should you take?
Not knowing what the Chancellor will announce, and when any changes will take effect, rather impairs our ability to answer that question!
However, if you are a higher rate taxpayer and were planning to make full use of your Annual Allowance anyway, or you were intending to take advantage of concepts such as Carry Forward or changing your Pension Input Period, it probably makes sense to consider bringing forward this payment to before the Budget on 8th July.
As to other action you should take, that’s not something we can advise in an article like this without knowing far more about your own circumstances. However, if you make contact with one of our advisers they will be only too happy to help you make the right decisions.
Call Sarah McCarthy or Bev Stoves on 0115 933 8433 or email info@investmentsense.co.uk
Please note
Any reference to tax relief is based on current HM Revenue & Customs guidance and is dependent on your individual circumstances which may change
