Pension savers are being warned to prepare for another ‘watershed’ moment in the forthcoming Budget, with major changes to the rules that dictate how we save for retirement on the cards.
As part of the Budget on 16 March, the Chancellor will also announce the results of the government’s consultation into pensions tax relief, which was announced in last summer’s post-election Budget.
Tom McPhail, head of retirement policy at Hargreaves Lansdown, says: “The reform will have to meet three criteria. It will have to save the government money, it will have to incentivise everyone to make adequate provision for their retirement, including higher earners but particularly the millions of ordinary workers who are currently under-saving. It will also have to make the system less complicated.”
Higher earners could be hit
Among the most likely changes expected to be announced is a reduction to the level of pensions tax relief given to higher earners.
Mr McPhail says: “We find it inconceivable that there will not be some further restriction to the overall rate of top-up enjoyed by the typical higher earner on their retirement savings.”
This would almost certainly include anti-forestalling measures to prevent a ‘last hurrah’ for wealthier investors.
“Assuming there are restrictions placed on tax relief, HMRC is almost inevitably going to introduce same-day measures to prevent any last minute tax relief leakage,” he explains.
Currently tax relief on pension contributions is based on the rate of income tax paid by the saver, effectively meaning all contributions are made from tax-free income. However, in addition to being expensive there are also concerns that it gives higher earners a greater incentive to save than lower paid workers.
One likely change is therefore the introduction of a flat rate incentive. Mr McPhail explains: “If you're going to replace tax relief, this looks to us like the most sensible option. Most of the debate has revolved around a rate of between 25% and 33%. This approach would be more egalitarian than the current tax relief system, it would also satisfy the simplicity test.”
Alternatively – but less likely – the government might favour a tiered top-up system that gives lower earning savers greater incentives than their better paid counterparts.
Mr McPhail explains: “This makes sense if the treasury wants to target the government's top-ups to favour lower earners, however it would potentially be more complicated to explain than the flat rate.”
Annual pensions allowance could fall
Other possible changes include reductions to the annual allowance and the lifetime allowance, which limit how much you can invest in a pension each year, and the total you are able to save during your lifetime.
Salary sacrifice schemes may also be curtailed in some way. Mr McPhail says: “The practice of employees giving up pay in exchange for tax-efficient employer pension contributions is now widespread (71% of employers use it) and is costing the government significant sums of money.”
Finally Mr McPhail adds that there is a good chance the Chancellor will reverse so-called pensions simplification, which saw defined contribution and defined benefit (final salary) both come under the same set of rules in April 2006.
“The two types of scheme are fundamentally different and should be treated as such. This 'carve out' would make it easier for the government to reform defined contribution pensions. It would also enable some of the inequalities between defined benefit and defined contributions to be ironed out.”