It is the time of year again when Budget predictions start to emerge. Every day there appears to be a different opinion on what will be waiting inside the chancellor’s red box.
I am not a fan of most of these prospective changes, as I feel the pensions industry has enough to deal with at present. That said, if there were to be a single change I could ask for it would be the abolition of the tapered annual allowance – but I won’t hold my breath.
Flat-rate tax relief
I have a lot of concerns over flat-rate tax relief, partly because I believe the current system isn’t broken, and partly because of the chaos it would cause. Given there would need to be more checks brought in to ensure the rules weren’t circumvented, any alteration wouldn’t be a simple case of changing the level of tax relief.
Take employer pension contributions, for example. These contributions are really just another payment to the employee, even though the money goes straight into their pension. The employee is receiving full marginal-rate tax relief on this payment because it isn’t a taxed benefit.
Therefore, in the event of new rules, employers could change contracts for employees to pay them a higher pension contribution and a lower salary. This isn’t salary sacrifice, because the employee would never have been entitled to the payment as salary, but the outcome is the same.
Higher-rate taxpayers would still be benefiting from higher-rate relief, even if the rules only offered personal contributions at a lower flat rate. This would mean that employer contributions would need to be monitored and the employee taxed accordingly to ensure no one is getting a different rate of tax relief into their pension. This could be done, but it would add another layer of complexity to the process and I am not sure it has been fully considered.
The same issues apply for salary sacrifice – I could see that salary sacrifice for pension contributions would need to be banned if flat-rate tax relief were to be brought in.
Defined benefit (DB) schemes face their own challenges. Many are underfunded and tax changes may see less funds going into the scheme from members, depending on the spread of taxpayers that are members. This could mean the employer would need to make up the difference to keep the scheme solvent.
In DB schemes, employer contributions are calculated based on the needs of the scheme. This means that contributions are not attributable to individual members in the same way as money purchase pension scheme contributions are. As a result, trying to ensure that higher-rate taxpayers aren’t getting more than their fair share would be impossible. DB schemes would therefore need to be excluded from these rules or have another test applied. We already have significant differences in the way money purchase and final salary schemes are treated, and this would just increase that discrepancy.
Flat-rate tax relief proposals have been shelved once before, and I hope they stay there – otherwise we could end up with not just a two-tier pension system, but a multilayered and even more complex tax relief system.
Annual allowance reduction
I would take a reduction in the annual allowance if it meant that the tapered annual allowance was abolished, but I can’t believe that is what is going to happen.
The annual allowance has reduced over the years from a peak of £255,000 down to what we have now, which is somewhere between £4,000 and £40,000 depending on how much you earn and what you have done with your pension benefits. The annual allowance was originally designed under the banner of pensions simplification and we are a long way from that now.
However, it is a relatively easy thing to do if you wish to reduce the tax relief that individuals are getting, which is why it has been hit more than once over the years, and why there is a process in place to recoup the tax relief for those that exceed it.
So if there is one change to be made by Philip Hammond, I feel this could be it. But I would very much hope that it doesn’t take place, unless the move also gets rid of the tapered annual allowance, the money purchase annual allowance, or both.
Lifetime allowance reduction
The lifetime allowance (LTA)generally gets a mention if you ask anyone about pension changes in the Budget, and this year is no different. But the fact that we are only a couple of years since the last drop, and that the allowance is currently on the increase, should be taken into account. Indeed, by the time this column appears, a further increase to the LTA for 2019-20 will have been pencilled in, because the rise is based on consumer price inflation in September.
The LTA is already very low, and many are being hit by charges when they access their benefits, when they reach age 75, or both. Reducing this further would certainly increase the tax take on pensions, but it wouldn’t do anything to encourage saving.
Should it happen, we would have to see another round of protections – such as fixed and individual protection – coming into force. Needless to say, this would continue to add complexity to the process of accessing benefits and testing the LTA. This is already a fairly poorly understood area outside of the financial services profession, and making it more complex will not help encourage saving.
Death benefits
Ever since pension freedoms came about, and with it the ability to pass funds down the generations tax-free, there has been a nervousness that these powers will be reversed.
Yet again, however, I don’t believe this will be the case. Such a move wouldn’t necessarily gain much for the government apart from ill will. The reason I say this is that those who have large funds to pass down the generations are, in all honesty, likely to live beyond age 75, at which point the funds then become taxable in the hands of the beneficiary.
Those with smaller funds are more likely to need to access their pensions, and so will be paying tax on them on their lifetime with little or nothing remaining to leave behind – even if they do die before the age of 75. Taking all this into account, not that much tax is really being lost. The biggest issue is not accessing funds at all, and those funds then remaining for many years beyond the original member’s death, but there isn’t much that can be done about this.
Abolition of PCLS
It wouldn’t be a Budget without the mention of the abolition of the pension commencement lump sum (PCLS). This rumour has come out every year for as long as I can remember and 2018 won’t be any different. Once again, I don’t believe that it will happen, but as usual there will be people who access their PCLS ahead of the Budget date just in case changes are made.
I used to believe that even if this did happen there would be some sort of protection in place for those that had already accrued an entitlement, but I am not as confident about this any more. That said, a change here looks unlikely, because the PCLS is one of the driving forces for savings, and although the government wants more tax revenue it also still wants people to save for retirement.
I believe this will be another quiet Budget for pensions – I hope so, at least. There are too many other things going on at the moment and there have been too many recent dramatic changes to warrant any more.
The government needs to focus on encouraging more pension saving and making either big changes or small tweaks that mean even more trust is lost will not help. Many of these changes would technically only impact the wealthy and those with larger pension funds, but a change is a change and still sends the same message. We want long-term pension planning, which can only be achieved with long-term consistent legislation we can work with.
I will be sat watching the Budget nervously, as I suspect many other people will too. Fingers crossed policymakers are too busy with Brexit to tamper with pensions this time around.
Claire Trott is head of pensions strategy at Technical Connection
