Frozen pensions are 'somewhat misleading' says Edwards
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As a surprise to many, pensions remained unscathed from Chancellor Jeremy Hunt’s Autumn Statement in November. A host of revenue-generating tax increases were announced, both on income and wealth, but the state pension triple lock was retained, and there were no amendments to pensions tax relief. However, this doesn’t mean they’re entirely “safe” next year, one expert warns – especially as more people invest in them to take advantage of tax relief.
Gary Smith, financial planning director at Evelyn Partners said: “The Office for Budget Responsibility’s (OBR) next outlook for the public finances will be key in determining whether pensions remain safe – from a tax crackdown on private pension saving, or modifications to the future state pension promise, or both.
“It’s possible that the more people pour into pensions to mitigate against income tax encroachment, the more the Treasury will be tempted to go after that money.”
Private pensions have long held a distinct advantage over most other nest-egg options of saving, thanks to the tax benefits they hold.
Contributions are boosted by tax relief (and possibly employer contributions), and pension growth tends to outstrip non-pension saving or investing – particularly for higher and additional rate taxpayers.
However, Mr Smith noted: “November’s Autumn Statement has just enhanced pensions’ relative attractiveness.”
Mr Hunt’s stealth tax raid means all income tax allowances and thresholds will fall in real terms until 2028 and the additional rate threshold will also fall in nominal terms from £150,000 to £125,140 – the level at which the personal allowance disappears – in April, affecting nearly 800,000 taxpayers.
Mr Smith said: “This has created an incentive to put more money into private pensions as that is one – and in most people’s cases, the only – way to mitigate against encroaching income tax.
“Those now earning between £125,140 and £150,000 will suddenly receive 45 percent – rather than 40 percent – tax relief on personal contributions once the additional rate threshold is reduced in April, making pension saving even more compelling for those cohorts.”
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Meanwhile, according to Evelyn Partner’s workings, it has been estimated that as many as two million people will eventually be subject to the effective 60 percent marginal tax rate that kicks in above £100,000 as earners start to lose their personal tax-exempt allowance.
Mr Smith said: “This could create another big incentive to shelter income in pensions.
“The tax raid on capital gains and dividends also means that savers who have used up ISA allowances should be more willing to accept the restrictions of pension saving in order to shield their wealth from taxation.
“Additionally, a further incentive for pension investing is that residual assets in modern defined contribution pension schemes can be passed on tax efficiently to beneficiaries. With the nil rate band for inheritance tax also frozen until 2028, pension saving will be increasingly relevant to those wanting to pass on their wealth tax efficiently.”
While the Autumn Statement has indicated that the Government are very much targeting savings and wealth for new revenue streams, if the Chancellor receives bad news from the OBR in the run-up to the Spring Budget, the perennial threat to the tax-privileged status of pensions could finally evolve into action.
Mr Smith said: “The most lucrative for the Treasury, but also the most controversial, would be to hack away at income tax relief for higher earners by cancelling higher and additional rate relief altogether and giving just basic rate relief at 20 percent to everyone.
“Some less drastic modification or harmonisation of relief rates might be more likely, but any such move will be administratively complex as it will probably require taking a spanner to the national PAYE system and company payrolls.”
Instead, Mr Smith continued: “The Treasury could just reduce the amount of savings that can benefit from tax relief by reducing the annual pension allowance that currently stands frozen at a gross amount of £40,000 for most people.
“Restricting tax-benefiting pension contributions to say £20,000 would be perceived as affecting only the well-paid who could afford to save such amounts. But with the duration and costs of retirement rising year by year, such a cull to the annual limit will put a cap on pension saving for many middle-to-higher-income professionals at a time when governments have been keen to encourage private pension saving.”
The lifetime allowance, which is the total amount a person can build up in pension savings without incurring a tax charge, has been frozen at £1,073,100. According to Evelyn Partners, evidence suggests this could be seen as a significant disincentive to staying in work for professionals who have built up large pots, particularly in public sector-defined benefit schemes.
Mr Smith said: “The Treasury will be watching closely as savers are bound, quite sensibly, to start putting more into pensions to protect their incomes and savings from tax.
“This in turn could limit the revenue-raising efficacy of Hunt’s tax grab, leaving pensions standing exposed and vulnerable as one of the last tax ‘safe-havens’.”
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