Will the latest pension cuts affect you?
In December's Autumn Statement Chancellor George Osborne announced that from 2014 the annual allowance for pensions would be cut from £50,000 to £40,000, while the lifetime allowance will be reduced from £1.5 million to £1.25 million.
This is the latest in a series of cuts the government has introduced to restrict the amount of money people can save into occupational and private pensions and get tax relief.
In April 2011, the annual allowance was slashed from £255,000 to the current level of £55,000, and the rule that allowed savers to invest as much as they could in the final year of their pension was also abolished. And last April, the lifetime allowance was cut from £1.8 million to £1.5 million.
Osborne has stated that the latest changes to the annual allowance should only affect 1% of savers, while the new lifetime allowance will only curb the savings of 2%. However, tax experts are concerned that the restrictions won't just hurt the super-rich.
In fact, plans to restrict tax relief for the wealthiest of pension savers could also affect some middle-income workers and exacerbate the financial divide between those with 'gold-plated' final salary pensions and those without them.
Not just 'fat cats'
As Mike Smedley, pensions partner at KPMG, says: "This will bring more ordinary people, not just 'fat cats', into the complicated area of tax charges on their pension entitlements."
This is because most people do not save in a uniform manner over their careers. "Pension saving is weighted towards the latter part of careers, after such things as housing and family costs have abated," he explains.
As retirement draws closer, many workers will opt to have bonuses and redundancies paid into their pension scheme, and this form of planning could be curtailed by the reduced allowance. "It is very common for employees to join salary and bonus sacrifice schemes because of the income and national insurance tax savings," adds Danny Cox, head of advice at Hargreaves Lansdown.
Likewise, many cash-poor small business owners will only be able to pay limited sums into their pension during their working life but may plan to stockpile money in it once they have sold their company.
The government may have only intended to limit tax relief on very high earners, however, thousands of people in final salary schemes, such as those working in the public sector, could be hit, too.
Thanks to the complex way in which their contributions are calculated (based on year-to-year growth in the fund's value, salary and length of service rather than actual contributions), many middle-income earners could be caught out if they are promoted or receive good pay rises, according to calculations made by pensions consultancy, Hymans Robertson.
For example, a worker with 35 years of service, earning £60,000 who received a 6% pay increase would see the notional value of their pension fund rise to £40,512, and would therefore be forced to pay a tax charge on the excess over the allowance (assuming inflation at 3%).
A person earning £70,000 would face a tax charge after 25 years of service, while somebody with a £90,000 salary would be stung by a tax bill after just 15 years.
"The longer your service and the bigger the promotion, the more you'll be affected," explains Chris Noon, partner at Hymans Robertson. "Those with aspiration, in particular, could really be hit by a tax bill," he adds.
Savers might be able to beat the tax charge by taking advantage of carry-forward rules, which allow you to use any unused capacity from the three previous tax years. But, warns Noon, "high achievers might not have any unused capacity to carry forward".
Final salary scheme members will no doubt resent any additional tax charge, but Noon points out they are still getting a good deal compared with members of defined contribution schemes, a fact that can be highlighted by examining the impact of the reduction to the lifetime allowance.
Based on current rates, the new £1.25 million lifetime allowance would typically buy a saver with a defined contribution scheme an income of £35,000.
"While it's a good income, £35,000 insurance tax savings," adds Danny Cox, certainly isn't a fat-cat pension," says Noon. However, that same size pot would give somebody on a final salary scheme a much more impressive annual income. "They will enjoy an annual income of £62,500 without any tax charge."
The changes announced in the Autumn Statement will still not affect the vast majority of savers. Nonetheless, experts are concerned that this continual changing of the rules – and the threat of further reductions – will only serve to undermine the wider public's confidence in pensions.
As Noon says: "Constant tinkering with the pensions system builds more distrust and apathy towards saving for retirement. We need stability in the system to allow employers and employees to plan their arrangements accordingly." He points to the success of individual savings accounts (ISAs), now used by approximately half the population.
"Contrast the trust in ISAs with the trust in pensions – with the exception of increasing ISA limits, regulation of them has been steady for years, and we've seen huge enthusiasm for them as a result."
Will there be more cuts to pension tax relief?
Reducing the amount of tax relief offered to wealthier savers appears to be an easy way for governments – irrespective of party – to tackle the deficit.
The coalition has made several successive reductions since it came into power and, in January, shadow chancellor Ed Balls announced that if Labour was re-elected it would restrict tax relief for those earning more than £150,000 to fund a new jobs guarantee for the long-term unemployed.
Danny Cox, head of advice at Hargreaves Lansdown, says: "I could easily see the annual allowance being chipped away to £25,000 or £30,000."
The abolition of tax relief at the higher rate for pensions has also long been mooted. Mike Smedley, pensions partner at KPMG, says: "I can foresee a position where you only get tax relief on the way in at 20%, only to get taxed at 40% on the way out."
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).