Posted on January 21st, 2016 | Categories - News
With George Osborne’s Budget set for 16th March, speculation is rife that following a Treasury led enquiry into how pensions are taxed, the system of tax-relief, designed to encourage savers, could be set for a significant overhaul.
Paying into a pension has long been a very tax-efficient way of saving for retirement, in no small part due to the top ups provided by the Government.
This system means that for every £80 a basic rate (20%) taxpayer pays into a pension, the Government adds £20.
A higher rate (40%) taxpayer can claim a further £20, taking the net cost to £60, with a 45% taxpayer able to claim back even more.
However, the system is expensive, costing the Treasury billions each year, whilst many experts are concerned that it higher earners, who can afford to make larger pension contributions, who are the real beneficiaries.
How might the system be changed?
It’s clear that the Government wants to encourage more people to save for retirement, indeed only this week David Gauke, the Financial Secretary to the Treasury, said: “We need to ensure it is effective in terms of encouraging saving, and it is going in the right place.
The Treasury is believed to have considered a number of radical options, including the possibility of completely scrapping tax-relief, but making pension payments tax-free when they are paid out to pensioners. This option would mean pensions look very similar to ISAs (Individual Savings Accounts).
Although this would produce the largest saving for Mr Osborne, it would represent an unprecedented change to the way pensions are taxed and would be extremely complicated to introduce.
The smart money therefore seems to be on a flat rate of tax-relief, paid to everyone, no matter what rate of income tax they pay on their earnings.
What might the flat rate be set at?
That really is the $64,000 question.
Experts are divided, with most suggesting that it could be set at between 25% and 30%. This would of course mean that there are winners and losers; basic rate taxpayers would be better off, whilst higher rate taxpayers would be entitled to a smaller top up to their pension contributions.
What action should you take now?
Of course no one knows what Mr Osborne will announce, which makes this an extremely hard question to answer.
However, if he does opt for a flat rate of tax relief, this is likely to leave basic rate taxpayers better off and hit those people who pay income tax at a rate of 40% or 45%.
To prevent an expensive rush of pension contributions between 16th March and the end of the tax-year, it is possible that the Chancellor might change the rules immediately.
Therefore, we would suggest that if you are a higher rate taxpayer, planning to make a lump sum pension contribution in the near future, you consider paying it into your pension before 16th March to guarantee you get 40% tax-relief.
Conversely, if you are a basic rate taxpayer and believe that any potential changes may mean you get a higher rate of tax-relief in the future, you may wish to consider delaying contributions until after the Budget.
We would of course recommend you take independent financial advice before making any decision, although even the best advisers don’t have crystal balls!
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