Tax  

Pension tax ratio could change

Pension tax ratio could change

The government could change the ratio used for defined benefit scheme valuations for tax purposes as a way to raise money, pension experts have warned.

This comes after the Supreme Court refused the government’s application to appeal a court ruling which stated changes made to judges' and firefighters' pension schemes were discriminatory.

Elizabeth Truss, chief secretary to the Treasury, revealed in January that if the government lost it could face a bill of about £4bn a year due to increased liabilities, if the ruling is applied to all applicable public service pension schemes.

Even though the final cost for the government won’t be known until the tribunals have determined the precise remedy to be applied, the government will need to find a way to fund this increase in benefits.

Alistair Cunningham, financial planning director at Wingate Financial Planning, said the obvious way would be "to address the apparent unfairness in the way DB pensions are assessed for the purposes of the lifetime allowance compared with money purchase pensions".

At the moment, to value DB schemes for LTA purposes the pension taken is multiplied by a factor of 20.

This means a £5,565 DB pension would use up a monetary amount of £105,500, and therefore use up 10 per cent of the current LTA, which is set at £1.05m.

The LTA represents the maximum amount of money a saver can save in their pension pot - and benefit from tax relief at their marginal rate - before incurring an additional tax charge of up to 55 per cent if taken as a lump sum or 25 per cent if taken as a pension.

The current 20:1 ratio was set in 2006, when the LTA concept was introduced as part of pensions simplification, and has not been changed since.

The rationale for the ratio is that it is the same as the amount needed to buy an equivalent annuity on the open market.

According to the current rules, an individual can take DB benefits tax free if they are worth £52,750 or less.

If the ratio was changed, to a factor of 40 for example, this figure would reduce to £26,375.

David Brooks, technical director at employee benefits consultancy Broadstone, told FTAdviser that making changes to the ratio would be an effective way of addressing the government’s problem.

He noted, however, that it would also impact private sector pensions.

He said: "The LTA is already unpopular with pension savers with the reductions (and its very imposition) being seen as a retrospective tax on earned benefits.

"You would have thought the unions celebrating the victory for their members would be angry if this move was taken to restrict their members’ pensions.

"That said, there is an overarching feeling of unfairness with the LTA multiple, which bears no relationship with the annuity a person could buy with their defined contribution savings. So, there is perennial feeling that the multiple, having been in place for 13 years, is ripe for review."