January 2, 2021
Reviewing old articles to rehash (*cough* I mean crafting new and original content) for my blog-hungry audience of around 5 people, I came across a piece from 2015 in which I wrung my hands for 1,000 words about whether the then Chancellor, George Osborne, would tinker with pension tax relief in the coming budget.
It was pretty much good to go after simply finding all instances of ‘George Osborne’ and replacing them with ‘Rishi Sunak’, then removing the references to how preposterously unlikely it was that the UK would vote to leave an enormous trading bloc with which it had preferential terms.
The funny thing is, it probably wouldn’t have taken much tinkering to make that article apply to the budgetary head-scratchings of Sir John Colepepper, and the concerns of whatever the equivalent of a financial adviser was in the 1600s (I call ‘antigropelos maker’).
Such is the cyclical nature of economies, we’re probably always worried about what set of apparently generous tax rules is about to be pulled because of some cataclysmic event that has just happened, or might be about to happen. It’s the lot of us wealth planners to be constantly wary about which clever planning tool might disappear in a puff of smoke.
Going back to 2015, there were whispers in the hushed and scholarly corridors of financial adviser firms (lol) that big changes were afoot for pensions. For example, an attack on salary sacrifice arrangements, removal of the tax privileged status of ‘Tax Free Cash’, a shift to flat rate tax relief instead of relief at your marginal rate, possibly even a fundamental reversal of the tax benefits that would see tax relief on contributions going into pensions replaced by tax free withdrawals on the way out (with EET becoming TEE - shout out to y’all acronym fans in the house).
Somewhat anticlimactically, we got a green paper, a bunch of articles speculating about the potential scope of any rule changes (including my own, cruelly overlooked for the Pulitzer Prize). And that’s about it.
Fast forward to 2021, and as everyone scrabbles to figure out how we’re going to plug the gap in the public finances caused by Covid, pension tax relief is back in the spotlight, in exactly the same way, and with exactly the same possible changes being kicked around.
This time, the rumours appear to focus on two areas - possible changes to the lifetime allowance (the maximum fund value you can build up in a pension in your lifetime before you’re hit with tax penalties), and the maximum rate of relief available on your contributions to pensions (the tax perk you get when your contributions go in).
I’m not going to speculate on whether these changes will happen (since I’ll only look stupid again in 2027 when they don’t). Suffice to say, it’s worth noting that pensions are historically one the more tinkered with areas of our tax rules, so it could be different this time.
But whether the rules do or don’t change this time, it’s useful to revisit how tax and pensions interact under the current rules, what makes pension rules look like such a juicy target for rapacious chancellors with books to balance, and therefore - might be worth making the most of in case it changes (because there is lots).
The basic way that individual pensions work has been pretty established for the last few decades. In simple terms, you get income tax relief on the way in, at the highest rate that you pay on your income from work. The fund grows more or less tax free until you retire. Then you get taxed on the income you receive from it at the end.
Because tax relief on your contributions is given at your ‘marginal rate’ (i.e. your highest rate), it looks like very good value for people who pay higher rate tax. £100 in a pension costs you £60.
It can also help you plan your way out of some funny anomalies in the income tax system. Because your ‘personal allowance’ (the amount of income you can earn before paying tax) is reduced when you earn above £100,000, earnings moderately above £100,000 can have an effective tax rate of 60%. This can be dealt with by making a pension contribution, which comes off the top of your income, getting you effective tax relief of 60%. In these cases, £100 in a pension costs you £40 and that’s the kind of tax relief that gets financial advisers properly hot under the collar, if you can imagine anything so disgusting.
One of the changes being talked about now (which also did the rounds in 2015) is a pretty fundamental change to the way tax relief works. IMHO it’s reasonable to argue that the current system is somewhat regressive, unfair even. 40% taxpayers get twice the incentive to save into pensions than 20% tax payers, who earn less.
One option would be to harmonise the rate of tax relief making it the same for everyone, at a flat rate somewhere in between basic and higher rate. Depending on what rate that was, this could net the government a hefty amount of extra tax.
It would be a progressive tax change (mathematically speaking) which makes it feel politically do-able.
The other possible change being talked about is a reduction in the lifetime allowance, from roughly £1m to £800,000.
This also seems feasible, on the basis that it looks like a rich person’s problem and the allowance has already been chopped before, having topped out at £1.8m between 2010 and 2012.
The issue is that although £1m sounds like a lot of money, likely to affect only small numbers of people, in reality it probably doesn’t buy you as lavish a retirement as you might think. If Sunak were to cut it any more, he’d risk being accused of messing with people’s relatively normal retirement plans.
But again, the current limit is still a pretty high ceiling, and a lot of money that can be built up in a very tax advantaged wrapper. History also suggests there would be ‘transitional protections’ for people who have breached, or are likely to breach, the reduced limit, although that wouldn’t be guaranteed.
So, what if anything should you do about all these possible changes, which might or might not happen? Well, pensions aren’t the right tax wrapper for everyone. They have limitations compared to other investment structures. Whether putting money into them is the right thing for you will depend on individual circumstances and goals.
But it probably isn’t a bad idea to fully explore and bank any advantages the current rules present you with, because they don’t tend to stay still for long. Good financial planners are always trying to hit moving targets, making the most of current tax rules and reviewing things as the legislative landscape shifts. If you’re not sure whether you’re maxing out the benefits of the current pension rules, get in touch for a chat.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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