Pension tax relief may be cut further

By Ian Pollock, Business reporter, BBC News


Government plans to restrict pension tax relief for the higher paid may be even more aggressive than those put in place by the previous Labour administration.

The coalition is planning to replace the big tax changes that Labour had put in place, starting next April.

These would have raised an extra £4.6bn by 2014-15.

However a Treasury consultation paper suggests a range of options, one of which might raise even more - £5.3bn.

The alternative proposals being put forward by the Treasury were welcomed by the National Association of Pension Funds (NAPF) which said they would be "less damaging" than Labour's plans.

"It's a simpler approach that that will encourage higher earners to stay in their workplace pensions, so helping protect pensions saving for all staff," said Joanne Segars of the NAPF.

Coalition plans
The Treasury suggests that each taxpayer's annual pension allowance - the amount their pension pot can grow tax free - should be slashed from the current £255,000 a year to between just £30,000 and £45,000 a year.

Under the Treasury plan, a £40,000 limit to the annual allowance - after which an extra tax bill would be generated - might be exceeded by someone whose pension entitlement in a final salary scheme had risen by just over £2,000 in a year.

Chas Roy-Chowdhury of the Association of Chartered Certified Accountants (ACCA) said the coalition's plans might catch more people in the tax net who were considerably lower paid than those targeted by Labour.

"It is still likely that many earning a lot less than the £130,000 could be affected where they are in a defined benefit (final salary) scheme," he said.

"This will depend on the valuation method and length of enrolment in the scheme but could affect even those on half the £130,000 especially if they make additional voluntary contributions (AVCs)," he warned.

Pay rise impact
To work out the increased value of someone's pension pot if they are a member of a defined contribution scheme is easy.

They are given an annual statement each year of the value of their pension investments.

However membership of a traditional final-salary scheme involves using a formula in which the rise in someone's accrued pension is multiplied by 10.

Thus a pay rise, perhaps due to promotion, which had the knock-on effect of increasing someone's pension entitlement by £4,000 in a year would currently fall within a £40,000 limit.

However the Treasury is suggesting that this annual accrual should be multiplied by much more, perhaps by 15 or even 20.

More tax
The Treasury consultation document illustrates the possible effects of the new approach.

Its figures suggest that by 2012-13, a £45,000 annual pension allowance would raise a similar amount to that expected under Labour's plans - in the region of £3.6bn.

But a lower £30,000 annual allowance would raise £4.8bn - £1.2bn more than Labour intended.

By 2014-15, an annual allowance of just £30,000 would raise an extra £5.3bn in tax while a £45,000 annual allowance would raise £3.9bn by that year.

Those estimates take into account the possibility that some taxpayers might tweak their pay arrangements to avoid breaching the new lower allowances.

Raj Mody of the accountancy firm PwC said it was possible that twice as many individuals in final salary pension schemes would breach the new limit.

For example, a 50-year-old employee in a typical final salary scheme earning £80,000 a year who, through promotion, got a 20% pay rise, could find themselves with an additional tax bill of over £10,000, he said.

"An unintended consequence of the new regime is therefore likely to be a continued shift of employers and individuals away from final salary schemes to defined contribution plans," Mr Mody added.

Labour's plans
With the highest rate of tax now at 50%, Labour had planned to restrict the amount of tax relief available to the highest paid.

It had calculated that in 2008-09 a quarter of all pension tax relief, worth £28.4bn that year, was going to the tiny minority of tax payers who earned more than £150,000 - worth an average of £20,000 a year each.

To rein in the new 50% tax relief now available on top earners' pension contributions, Labour put in place two changes due to start next April.

The first was that tax relief would be tapered away from 50% down to 20% as people's incomes rose above the £150,000 level.

The second and more profound change affected those with incomes of more than £130,000.

If the value of their employer's pension contributions, when added to their personal income, took their gross income over £150,000, then they would start to be taxed on the value of those employer contributions at a rate of as much as 30%.

This approach was widely criticised as far too complex.

Many experts suggested that the coalition, if it still wished to rein in tax relief for higher earners, should simply restrict the amount by which anyone's pension pot could grow each year before it started to lose tax relief.

That is the plan on which the Treasury is now consulting.

Posted by Joe Martin providing business services for small businesses and the self employed. Find me at joemartin.co.uk