Budget 2016: Pensions tax doesn’t have to be taxing… does it?

Published by Tyron Potts on

Speculation is mounting ahead of the upcoming Budget that the Treasury’s response to its Green Paper on pensions tax relief1 will bring controversial and wide-ranging reforms.  In this blog, we separate rumour from fact and consider what one might do to prepare in advance, in case some of these changes are announced by the Chancellor on 16 March.

There are some other tax-related actions individuals ought to be considering now, regardless of what we expect will be in the Budget.

In spite of fervent opposition to many of the proposals put forward in the Green Paper, the Government effectively has carte blanche – and a strong political incentive - to reform the pensions taxation system now.  We are, after all, four years from the next general election which in political terms could be considered aeons.   The Chancellor can afford to take a long-shot as the payoff could be spectacular for him personally, and for his political party.

The pensions tax changes that could be on the cards would have a significant impact on the tax advantages of pensions saving – costing higher rate taxpayers in favour of lower earners.   If the rumours are to be believed, then for many, delaying making pensions contributions until after the 2016 Budget may not be tax-advantageous, and opportunities could be lost.   Anyone in this position should consider their options with their advisors carefully.

The options – Green Paper

In last year’s green paper, the Government mooted a number of potential structures for reformation of pensions taxation - all of which are, at least in theory, still on the table:

Moving from exempt-exempt-taxed (EET) to taxed-exempt-exempt (TEE):

(see our blog post here and Adrian Waddingham’s article here).

There is considerable opposition in the pensions industry to the introduction of a ‘Pensions ISA’ system where, unlike now, contributions are taxed on the way in, but benefits and investment returns attract tax relief in the accumulation phase.

Whilst this option has the added advantage of accelerating income tax receipts, helping to address the budget deficit, recent rumours suggest that the government may no longer be considering this option in earnest, instead focussing their energy on…

Pension contributions currently attract tax relief at an individual’s highest marginal rate, provided the Annual Allowance (AA) is not breached (although you can carry-forward unused allowances for up to three years).

Instead, a single rate of relief, in the form of a bonus / matching contribution set at an appropriate rate (somewhere between 25% and 35% say) could further incentivise basic rate tax-payers, at the cost of lost relief for higher rate payers).

If the Government is to introduce a flat rate of tax relief, higher-rate tax payers considering making pensions contributions may want to consider with their advisers whether and how to reflect this in their pension contribution planning. 

It could be argued that the current system is generally fit for purpose.

Despite successive tweaks to the AA and Lifetime Allowance (LTA), we could yet see more adjustments in order to bring in further tax income to help plug the budget deficit. 

Speculation

Just because certain options weren’t explicitly outlined in the Green Paper, does not mean the Treasury hasn’t also considered giving them a surprise role in the Budget.

For example:

Former pensions minister Steve Webb has said that he would not be surprised to see the Chancellor making a grab for the ‘tax-free’ lump sum (known as Pension Commencement Lump Sum).   Although such rumours persist at almost every budget and autumn statement, this ‘low-hanging’ fruit might be too tempting for a Chancellor trying to balance the books to resist.

The Treasury would encounter a great deal of push-back from the industry on behalf of those who have factored the tax-free lump sum into their retirement plans.   This would seem reason enough not to apply any tax charges retrospectively, but it would be short-sighted to discount the possibility entirely.

Individuals who are planning for retirement in the near-term may want to consider with their advisers whether to reflect the possibility of such changes in their plans.

The Treasury is known to be monitoring the use of salary sacrifice arrangements which can produce significant National Insurance (NI) savings – which are often passed to the employee, at least in part.   Outright abolition could be tricky given the prevalent use of salary sacrifice in other elements of employee remuneration packages, but the Government may consider capping the NI reductions on an individual basis.  

The removal of salary sacrifice may form part of a longer-standing desire on the part of the Treasury  to merge tax and NI.

Other opportunities

Notwithstanding the content of Budget 2016, the current regime presents a number of opportunities which are time-limited, including:

A one-off additional allowance of up to £40,000

The assessment against the AA is made over a ‘Pension Input Period’ (PIP) which in the past was not necessarily the same as a tax-year (as some arrangements had been free to define their own PIP). 

At last summer’s budget, the Treasury announced that all PIPs would be aligned with tax years.   As a result PIPs running over 2015/16 were shortened to end on 8 July 2015 and a new mini-PIP started for the period 9 July to 5 April 2016.  To ensure nobody lost out, an extra allowance of up to £40,000 applied for the new mini-PIP.

Tax Year

Annual Allowance 

2012/13

£50,000

2013/14

£50,000

2014/15

£40,000

To 8 July 2015 (PIP A)

£80,000

9 Jul to 5 Apr 2016 (PIP B)

LOWER of £40,000  and
(£80,000 - actual contribution in PIP A)

2012/13 carry-forward ends 5 April 2016

The carry-forward regime requires you to use up the all of current year’s allowance (ie for period to 5 Apr 2016) before drawing on unused allowances.  Therefore the opportunity to use the unused 2012/13 allowances will be lost after 5 April 2016.

"Individuals who think they may be affected should seek advice and plan carefully with their advisers how best to structure pension provision to minimise any potential tax impact."

Tapered AA effective 6 April 2016

From 6 April, the AA for those whose total income is more than £150,000 per year will reduce on a sliding scale such that if your total income is over £210,000, then only £10,000 a year could be contributed (without incurring an AA charge) to a pension arrangement.  The annual income calculation must take into account the value of employer contributions / accrual to a pension arrangement, as well as income from all sources (e.g. salary, bonus, taxable interest on savings, dividends income, rental income, P11D benefits, and any pension income).

Individuals who think they may be affected should seek advice and plan carefully with their advisers how best to structure pension provision to minimise any potential tax impact.

Changes to LTA 

As it stands, the LTA will reduce from £1.25 million to £1 million from 6 April 2016.   Two new protection regimes (‘FP 16’ and ‘IP 16’) will be in place shortly to protect those with pension savings valued above £1 million at April 2016.

Advice and planning will be required to ensure that the protections are properly applied for.

The next steps

Nobody, apart from a few Treasury insiders, yet knows what the Chancellor has in store for us on 16 March.   Nevertheless, some considered planning ahead of the Budget could save some financial headaches.

  1. See Green Paper on Pensions Tax Relief - 'Strengthening the incentive to save'

BLOG

James Jones-Tinsley discusses the reform of pensions tax relief

BRIEFING

Transitional provisions for aligning PIPs

BLOG

Time for action on the tapered annual allowance