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Re-emerging threat

26 October 2016

One month before the new chancellor delivers his Autumn Statement, rumours of threats to higher rate tax relief have resurfaced.

With just under a month to go until Philip Hammond delivers his first Autumn Statement, there is renewed speculation over whether the new chancellor will take the opportunity to review pension tax relief.

Currently, the government pays tax relief on pension contributions subject to the ‘annual allowance’ limit. The rate of tax relief is based on an individual’s highest marginal rate of Income Tax, so anyone who pays tax at higher rates gets at least 40% added to their pension contributions – assuming their full entitlement is claimed through their tax return – while basic rate taxpayers receive 20%.

But despite the attractive tax breaks on offer, the system has so far failed to encourage ‘millennials’ to make sufficient provision for their retirement, while critics claim it is unfairly weighted in favour of high earners.

The government has made no secret of the fact that it needs to encourage more people to take responsibility for retirement saving. Indeed, various suggestions for reform were tabled last year and it was widely expected that these would be enacted earlier this year. Yet the consultation failed to reach consensus, and the proposals were all but crushed once the threat of a backbench rebellion emerged. But although the former chancellor was forced to admit defeat, he did leave the door open to future reform.

Scale of change

While any further attempts to tinker with pensions will be opposed by those who are calling for a period of stability, tax relief will inevitably be under the spotlight again in the run-up to the Autumn Statement on 23 November.

Moreover, it has now emerged that the Treasury is considering a new policy that slants the incentive to save for retirement towards younger generations. Under the new proposal, the government would scrap tax relief entirely, and offer everyone £100, minus their age, for every £100 they pay into their pension. For instance, a 30-year old would receive a top-up of £70 for every £100 invested, while a 60-year-old would get a top-up of £40 for every £100 saved.

When asked if an age-based incentive was being considered, the chancellor’s parliamentary private secretary, John Glen, said the idea would “be consistent with a government that wants to help working people”.

But while the policy is in line with the government’s ambition to help younger people and make the support on offer simple and transparent, it does risk alienating older voters, especially those who plan to boost tax-relievable contributions as they approach retirement.

A less radical solution would see tax relief maintained, but the link between it and income broken, with a flat rate of somewhere between 20% and 30% for everyone. A flat rate of 30% would represent an added incentive to basic rate taxpayers, but high earners would be worse off.

Alternatively, the pension ISA idea floated during last year’s Summer Budget could yet see the light of day, despite it being perhaps the most controversial proposal. This would remove upfront tax relief in return for a promise that the entire pension pot could be drawn tax-free in retirement.

This idea has been rebuked by former pensions minister, Ros Altmann, who remains in favour of the behavioural incentives that underpin the current system. She says that paying Income Tax on withdrawals in retirement provides the natural brake on taking the money too soon.

“It’s really important, I think, to keep pensions and their powerful financial and behavioural nudges from being turned into inferior ISAs. Pensions have now got, to a significantly greater extent than before, the right behavioural nudges,” she says.

Lurking danger

Predicting changes ahead of the Autumn Statement is, of course, nothing more than crystal ball-gazing. But what is clear is that the annual tax relief bill for pensions – £35 billion a year1 – remains an enormous burden for the government to shoulder, especially at a time of scarce public money. Therefore, an immediate overhaul of tax relief on 23 November remains a possibility.

Given this environment, investors will be considering what action to take. Ian Price, Divisional Director at St. James’s Place, recommends that people look at their options with their financial adviser, but believes that tax privileges for higher earners are very unlikely to become more attractive.

“If you’re a higher rate taxpayer, with the available cash and remaining pension allowances, it would make sense to bring forward pension contributions to before 23 November. It makes little sense in holding off. You are very unlikely to be in a worse position if you contribute today,” he says.

Some will look to the economy for clues. The keystone of every Autumn Statement is the official economic forecast by the Office for Budget Responsibility. Last year’s forecasts were better than expected, giving the former chancellor room to curb his spending cuts. But a year on, an EU referendum result that has caused a drag on the economy leads to inevitable questions about where further cuts could or should be made.

Against this backdrop, the new prime minister and chancellor may see removing tax breaks for higher earners as easy to sell to the general public and consistent with attracting centre-ground support.

 

1 Strengthening the incentive to save: a consultation on pensions tax relief, HM Treasury, July 2015 

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise.  You may get back less than the amount invested.

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