The summer budget brought new rules and limits on contributions to UK pension plans and more changes may be forthcoming in the budget on 16 March 2016.
I read with interest this weekend, the Association of British Insurers assessment of how the government might best change the current pension regime, which proposes a flat rate of tax relief and poses the possibility of a ‘Pension ISA’.
The current tax regime in relation to pension contributions
As a reminder of where we stand post July and that summer budget. The annual allowance, which is broadly the amount one can put into a pension each ‘year’ (previously referring to a pension input period rather than per tax year), is currently £40,000 for 15/16. There were also tweaks in there to bring pension input periods in line with the tax year (very sensible) and a transitional peculiarity that meant those who contributed to their pension before the budget announcement got an extra £40,000 annual allowance. That is all by the by now.
In July the chancellor announced that from 6 April 2016, so tax year 2016/17, the annual allowance would be tapered down to a minimum amount of £10,000 for high earners. So if you earned more than £210,000 you will have an annual allowance of £10,000 which is the most you can contribute and get tax relief.
There will still be a carry forward of the three preceding tax years’ unused annual allowance. That aspect alone means we will be talking to clients in the run up to March, who fall into the high earners category, in order that they can maximise the available annual allowance and potential tax relief on pension contribution before the £10,000 limit applies and their carry forward years drop off.
The government also has a consultation open as to what the future of pensions should look like and this weekend the Association of British Insurers (ABI) publicised their response to the consultation. It is not to say that this is what will happen but it is worth the thought experiment, not least because I have seen other reports in the FT and the like with similar comments.
A proposal for a single flat rate tax relief on pension contributions
The ABI proposal gets rid of the tax relief as it exists now and replaces it with a flat rate ‘savers’ bonus’ based on a single rate of tax relief in a range of 25% – 33%. Taking a 25% bonus as an example, taxpayers would receive a £1 into their pension for every £3 they contribute (it is not clear If the annual allowance would remain in its current guise or not). The ABI say this will see low and middle earners potentially receiving more tax relief than tax paid (that would be the ‘bonus’), and those paying the additional rate tax of 45% missing out on some 12-20% of tax relief.
If such a regime were to be brought in would it deter those additional rate taxpayers from making pension contributions? It may but the ABI suggests that this will be fair as many of these additional rate taxpayers will be basic rate taxpayers in retirement and thus pay lower tax rates when they withdraw their pension. I would suggest that the speculation alone will be sufficient incentive for those who have the available funds, to make contributions that use their available allowances in full, before the chancellor stands up in March.
For me, the change to curtail the annual allowance has already heavily restricted the amount that clients can and would want to contribute to a pension from a tax perspective before even considering flat rate relief. When you factor in the constant changes to pension rules and allowances (including the lifetime allowance) with each government and currently, almost yearly, it is hard to muster the confidence to pay tax and lock up your net earnings in such a vehicle until you reach retirement – that will be in spite of the attractive tax regime at retirement, 25% tax free lump sum (US taxpayers will need further guidance on this point), lower tax rates generally at retirement, no need now to buy an annuity and improvements to the taxation when a pension is inherited. Remember, careful financial and retirement planning and not just tax is also a consideration here.
Our suggestion to individuals for now would be to have in mind the potential for tax changes announced in March, review their previous pension contributions and establish their carry forward allowance and consider whether to utilise that in this tax year and potentially before the budget.
Could we see a Pension ISA introduced?
The ABI also mention the prospect of a ‘Pension ISA’. I’m not sure that this will take off but regardless individuals already have access to ISAs and can contribute up to £15,000 a tax year into a stocks and shares ISA. You contribute net after tax income but the income and growth in the ISA is tax free and there is no tax on withdrawal. For those subject to the £10,000 annual allowance cap or missing out under a flat rate pension relief might find their ISA becomes a more important part of their retirement saving.
For those US taxpayers the Pension ISA concept will already look familiar being somewhat similar to a ROTH IRA. The benefit for a US taxpayer would be the potential for a Pension ISA to be covered by the tax treaty between the UK and the US and to be exempt from US tax where current ISA accounts are not.
Finally US taxpayers need to take care if making pension contributions as to the availability of foreign tax credits against their taxable income in the US (commonly we talk about ‘using excess foreign tax credits’) and in regard to the necessary US reporting associated with foreign pensions.
Ingleton Partners only comments on tax matters and does not provide investment advice – as such individuals should consult their financial adviser on these matters too before deciding whether to make pension contributions.