Impact of annual allowance cut questioned

Impact of annual allowance cut questioned

The government is expected to cut the annual allowance in half in the next budget to achieve its aim of funding the NHS, but pension experts have questioned the impact the measure would have.

The government plans to provide an extra £20.5bn funding for the NHS by 2023/24 and is looking for ways to drum up the cash.

Some of the money is expected to come from the cash the government will no longer spend on the annual membership subscription to the European Union after Brexit, but the remaining funds will come from taxpayers.

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The overall cost of pension tax relief stood at £38.6bn in 2016 to 2017, according to data from HM Revenue & Customs (HMRC), and, according to media reports this weekend, a cut to higher rate pensions tax relief is in the works.

But pension experts have told FTAdviser they foresee a 50 per cent cut to the annual allowance, which limits the amount people can contribute to their pensions each year tax free.

Currently this limit is set at £40,000 a year. If reduced to £20,000, this would mean a high earner with a 40 per cent tax rate would only receive £8,000 of tax relief, instead of the current £16,000, according to calculations from insurer NFU Mutual.

Malcolm McLean, senior consultant at Barnett Waddingham, is expecting the chancellor to cut the annual allowance alongside bringing in a flat rate of tax relief at 25 per cent.

This "would actually hit the higher earners, but it would also give a slight increase to standard rate tax payers," he said.

The impact of the allowance cut by itself would be limited, he explained. "Most of people that contribute to a pension plan put in fairly small amounts, they don't get up to the £40,000 a year figure," he said.

Rachel Vahey, product technical manager at Nucleus, agreed the benefit for the government of cutting the AA was not clear cut.

The biggest proportion of the overall cost of tax relief last year was made up of contributions paid by employers to occupational schemes, often to defined benefit (DB) schemes, and recovery plan contributions, Ms Vahey explained.

She said: "Cutting the annual allowance would mean lower pension contributions but wouldn’t have any effect on recovery plan contributions.

"It may also affect members of DB schemes who have many years’ service, and may find they are bumping up against the annual allowance."

Ms Vahey noted that another possible solution was to reduce the threshold for the tapered annual allowance - which is applied to high earners, and means that for every £2 of income above £150,000 per annum, £1 of annual allowance will be lost.

Mr McLean said this allowance should be scrapped, saying it was not understood by taxpayers, and would help to simplify the rules.

Sean McCann, chartered financial planner at NFU Mutual, agreed.

He said: "We could see drastic simplification of pension tax relief in the next budget. The Treasury’s dilemma is it has to raise revenue without raising taxes. A cut to the amount people can pay into their pension seems increasingly likely.