With spring nearly upon us, is it time for a spring clean? If rumours are to be believed, that is certainly what the government are planning when it comes to pensions in the forthcoming 16 March 2016 Budget. Indeed, further pension changes are one of the strongest rumours about this Budget.
Current position
Tax relief is provided on pensions contributions at what is known as an individual’s marginal rate of tax:
For example, consider a personal pension contribution of £800 in cash.
£800 goes into the pension fund and the government tops the fund up by a further £200.
In effect, £1,000 in the pension fund for a £800 personal contribution, i.e. 20% tax relief
2. Higher rate tax payer (taxable income over £42,385 per current tax year, expected to become £43,000 from 6 April 2016):
£800 goes into the pension fund and the government tops the fund up by a further £200.
In addition, the basic rate tax band is extended by the grossed up pension contribution (£800 + £200) being £1,000. This moves £1,000 of income from being taxed at 40% to 20%.
In effect, £1,000 into the pension fund for a £800 personal cash contribution, i.e. 20% tax relief plus a further 20% tax saving of £200 from the extension of the basic rate tax band, being 40% tax relief overall. Therefore, a cost of £600 to get £1,000 into the pension fund.
3. Additional rate tax payer (taxable income over £150,000 per current tax year):
£800 goes into the pension fund and the government tops the fund up by a further £200.
In addition, the basic rate tax band is extended by the grossed up pension contribution (£800 + £200) being £1,000. This moves £1,000 of income from being taxed at 45% to 20%.
In effect, £1,000 into the pension fund for a £800 personal cash contribution, i.e. 20% tax relief plus a further 25% tax saving of £250 from the extension of the basic rate tax band, being 45% tax relief overall. Therefore, a cost of £550 to get £1,000 into the pension fund.
By way of contrast, practice owners trading through a company might historically have had the company make pension contributions into their funds. This saves company corporation tax at 20%, e.g. £1,000 contribution reducing the company’s corporation tax bill by £200. A further saving can arise from not having to extract cash from the company (which is potentially taxable depending on how it is taken) to instead make the pension contribution personally.
Possible changes
Whilst the proof will be in the pudding, possible changes that have been suggested include:
1. A single pensions savings incentive, i.e. flat rate of tax relief whether someone is a basic rate, higher tax or additional rate tax payer. Figures of between 20% to 33% have been most widely talked about, but of course the Chancellor could surprise us with something different.
The Pensions Policy Institute have indicated that whilst basic rate tax payers make around 50% of total pension contributions, they only benefit from approximately 30% of the tax relief. Such a change would therefore potentially make the tax relief more progressive, i.e. tax relief shared more evenly between tax payers.
2. An alternative being that pensions becoming more like ISAs have also been mooted – a Pensions ISA. Whilst some consider this to be a less likely, it should not be ruled out. The idea being that no tax relief would be available when pension contributions are made, but pensions not being taxable when taken. As with all of this, there remains uncertainty until firm announcements are made. This would be the reverse of the current system where currently tax relief is provided when pension contributions are made and pensions taken being taxable.
3. Abolishment of the 25% tax free lump sum that can be taken upon retirement. Whilst it is possible that such a change could apply retrospectively, it is much more likely that such a change would affect future contributions only.
4. Possible further changes to the pensions Annual Allowance. This is currently £40,000 per annum and is the limit on total pension contributions (both personally and from a company) that can be made with tax relief being available. Unused Annual Allowance in the previous three years can be used to top up your current year’s allowance. Could the threshold of £40,000 be reduced further? It remains to be seen.
It is also worth noting that as previously advised, that from 6 April 2016 onwards the annual allowance for tax relieved pension savings will be reduced for those with incomes of more than £150,000. The annual allowance will be reduced by £1 for every £2 of income individuals have in excess of £150,000 with a maximum reduction of £30,000.
This would see those earning over £210,000 in a given tax year (6 April to the following 5 April) receiving an allowance of £10,000, with a sliding scale from £40,000 to £10,000 for those earning between £150,000 and £210,000.
For those trading through a company, company profits are not relevant here, it is an individual’s income in that tax year that is key.
It also means that those with earnings in excess of £150,000 who were thinking of making a significant pension contribution should perhaps consider doing this in the 2015/16 tax year (ending on 5 April 2016), as this will provide more flexibility and scope.
5. Possible further changes to the pensions Lifetime Allowance which is due to reduce from the current £1.25m to £1m from 6 April 2016. Back in 2010, it reached a height of £1.8m and has been reducing since. Pension funds in excess of the Lifetime Allowance are taxed at 55% if taken as a lump sum or 25% if received any other way. Could the threshold of £1m effective be 6 April 2016 be changed to a lower limit? It remains to be seen.
When might changes comes in?
To some degree, who knows, although around 12 months post Budget has been mentioned as a possibility in the media for some of the above. Of course, it might well be that some changes could come in much earlier or immediately.
Who to speak with if you have any questions
We are able to advise on the tax implications of making pension contributions. You should speak with your financial advisor in terms of investment advice and making pension contributions.