Pensions Tax Relief – Loss of Higher Rate Relief?
After several years of speculation, fears are growing that Chancellor George Osborne is finally poised to take away higher-rate tax relief for pension contributions. If this the case, then the vital cut-off date for investors could well be Wednesday 16th March – the day of his next Budget.
Tax sweetener set to be abolished
At present, taxpayers earn tax relief on their pension contributions at what’s known as their highest personal marginal rate of tax.
So for basic-rate (20%) taxpayers, a £100 pension contribution costs just £80 after £20 of tax relief.
For higher-rate (40%) taxpayers, a net £60 is needed to make a £100 contribution, with £40 in tax relief.
And for additional-rate (45%) taxpayers, the net figure falls to £55, plus £45 in tax relief.
However, various media reports say the Treasury now appears to have concrete plans to end pension tax relief at the 20%, 40% and 45% rates, instead replacing it with a universal tax relief at a single, flat rate.
This flat-rate relief will surely be higher than 20% and lower than 40%, with 33% an oft-quoted middle ground.
Of course, what this means is that 40% and 45% taxpayers will be worse off, as they will lose valuable tax relief. On the other hand, tax relief rising from 20% to, say, 33% will hugely benefit 20% taxpayers. In fact, the higher the flat rate of relief, the better-off basic-rate taxpayers and non-taxpayers will be.
When might this happen?
As is normal with Budget announcements, were the Chancellor to alter pension tax relief then this change would normally take effect from the start of the next tax year or the one thereafter. The 2016/17 tax year begins on 6th April, so this appears to be the earliest point it could be introduced.
With the Chancellor’s Budget speech taking place on 16th March, this would give you 21 days to pour money into your pension in order to secure last-minute tax relief at 40% or 45%.
Because of this it’s highly likely the Chancellor will also announce ‘anti-forestalling’ measures in his Budget speech, so as to end higher rates of pension tax relief on that same day. Otherwise, investment company Hargreaves Lansdown reckons the Treasury could lose £6 billion in extra tax relief as a wave of money pours into pensions between Budget Day and the end of the tax year.
This is a big opportunity for all workers
If higher rates of pension tax relief do end on 16th March, then this pension reform produces two very different outcomes for workers, depending on their personal incomes.
For higher- and additional-rate taxpayers, the best strategy is to maximise your pension contributions before 16th March, either through lump sums or by bringing forward future contributions to be made on or before 15th March.
However, for basic-rate taxpayers, the optimal strategy is quite the opposite. You should delay planned pension contributions until after 5th April, as this may allow you to claim higher tax relief at the new flat rate.
What flat-rate relief would be worth?
Clearly, the higher the flat rate of tax relief, the better off low earners will be.
With flat-rate relief at 33%, for every £2 you pay in the Government adds £1. With relief at 25%, the Government would add £1 to every £3 you contribute. Similarly, with 30% relief, for every £7 you pay in the Government adds £3.
Either act now or sit back and wait
In summary, regardless of your pension arrangements (whether private, company or otherwise), you may need to act fast in order to claim maximum tax relief if you’re a higher earner.
On the other hand, if you’re a basic-rate taxpayer or non-taxpayer, then sit back and await developments, as delaying your contributions could bring you far greater rewards from April onwards!
Loss of Tax Free Cash
Former pensions minister Steve Webb has warned of the end of the tax-free lump sum that can be taken from pensions.
This has made clients ask themselves whether to take their 25% tax free-lump sums now.
The current perk allows people to access 25% of their pension pots tax-free in a single lump sum when they reach 55. This benefit could be “heading for extinction”, Mr Webb wrote at the weekend.
However, Mr Webb has now clarified that the death of the tax-free 25pc – a “tax bombshell” – most likely relates to future saving under a new system rather than pension money already accrued.
What are the downsides of taking your tax-free lump sum now?
If you have a large pension and are in danger of paying higher rate (40pc) tax as a pensioner – we typically advise against taking your tax-free lump sum upfront. Instead you can opt to take a part of your lump sum every year in order to keep under the higher rate tax threshold of £42,385.
By removing all of your tax-free cash now, you take the cash from an environment where the asset is able to grow free of income tax and capital gains tax to an environment where it would be taxed. In addition by removing the assets from the pension the asset becomes part of your estate for Inheritance Tax purposes.
What are my options?
Depending upon the value of your tax-free cash available you can of course use it to fund ISA’s and if doing so for both husband and wife, you could ensure that £60,960 would be shielded from both income and capital gains taxes. (Providing you have not used your 2015/16 ISA allowances.)
Anything over and above £60,960 could be placed into a General Investment Account which would be subject to capital gains tax, savings income tax, and dividend income tax.
We would however, each financial year, aim to ensure that you are invested in the most tax-efficient investment vehicle in order to maximise the impact of any potential investment growth by utilising your annual capital gains tax allowance, which is currently £11,100 per year to fund ISAs. Not only will this make your investment portfolio more tax efficient but also potentially reduce the burden of reporting on your tax return.
In removing the tax-free cash from your pension before age 75, you do add the assets to your estate which if your estate is over the £325,000 limit for individuals or £650,000 for couples would be subject to 40% Inheritance tax.