Tax relief on pension savings costs the government an awful lot of money.
It is worth noting that pensions tax relief figures are estimated, and apparently subject to a high margin of error - the most recently released figures indicate that income tax relief on pension accrual cost the government £38.6bn in 2016 to 2017.
That is mitigated somewhat by the tax take from pension payments of £13.5bn, but a net cost of over £25bn remains a significant drain on the Treasury.
When you throw in the National Insurance relief on employer contributions (£16.2bn in 2016 to 2017) and consider that increases in minimum contribution levels associated with auto-enrolment will cost the government more among lower to middle earners, it’s not surprising that pressure has continued to grow on pension savings limits which typically, if not always, affect those with higher earnings.
If a government already thinks it is spending too much on pensions tax relief, and those costs are going to increase for some savers, pressure is eventually going to be felt elsewhere.
The government attempted to look at structural change to pensions tax relief as recently as 2015 with its consultation on ‘Strengthening the incentive to save’. The consultation eventually closed with the Treasury concluding that significant structural change should be placed in the “too difficult” bucket.
But the government imposed cost controls in other ways through the reduction of the annual allowance itself to £40,000, the introduction of a tapered annual allowance potentially limiting pensions accrual to as little as £10,000 for those with high incomes, and also the introduction of the money purchase annual allowance (MPAA) of £10,000 (with a further squeeze when the MPAA was reduced to £4,000 from April 2017).
Given the extent of recent changes, and the potential for more in the not too distant future, it is perhaps worth catching our breath, taking a look at where things stand, where they might change in the future, and what planning opportunities might arise.
Pensions tax relief – the basics
Starting with the basics, the annual allowance is a control that covers savings into pensions. However, it is not the only control.
The annual allowance, currently £40,000, covers savings of all forms into all registered pension schemes – so employee and employer contributions into defined contribution (DC) schemes as well as accrual into defined benefit (DB) arrangements – but we also have to remember the earnings based limit which covers contributions made by individuals into DC and, where relevant, DB pension schemes.
Although those two separate controls have been in place for more than a dozen years, they still have the potential to confuse clients.
A look at internet forums frequented by savers shows many find the combination of the earnings limit and annual allowance challenging to understand, so it is worth reminding ourselves of the interaction.