The future for pensions…
Further to the unprecedented reforms to pensions outlined in 2014, the government also announced in the 2015 budget that they plan to reform how tax relief was granted on pensions.
At present, broadly speaking, you get tax relief on the way in, tax free growth on investments whilst within the pensions wrapper and then a tax free lump sum of 25% on drawing your benefits, with any further withdrawals subject to income tax at your marginal rate.
The government has gradually between reducing the amount you can contribute and obtain full tax relief: first by reducing the annual limit to £50K, then £40K, and now £10K for some very high earners. No real surprise when you consider that pension tax relief costs the Treasury around £35 billion each year.
They are currently consulting on a new pensions tax system but no one can really be sure what the outcome will be.
One suggestion is that pensions could become more ISA-style in terms of the tax reliefs available. In simple terms, that means there would be no tax relief on the way in, but growth would be tax free whilst within the pensions wrapper and any income and capital drawn out would also be free from tax.
In many ways, this would make the pensions saving regime a lot easier to understand, but many industry commentators have concerns that long-term pension savers would lose out. Tax relief going in means that more money is paid into your pension pot at outset. Abolishing tax relief would not only mean that you miss out on that initial uplift, but also miss out on any future growth on that uplift – the compounding effect.
Indeed Hugh Pemberton, of the University of Bristol, has suggested that the net effect on the ultimate pension pot of a basic rate taxpayer could be a reduction of around 17%. This means a lower income of around 7% a year (after tax) in retirement.
At a time when the government is doing all it can to encourage young people to save for retirement, some suggest that such a strategy is not the answer. Those commentators suggest that the government should instead consider removing higher-rate relief going in, restricting tax relief to the basic rate of 20% only. This could be a better result for basic rate taxpayers, but what of those higher-rate tax payers who maximise their contributions every year?
Only time will tell, but safe to say the government is not finished playing around with pensions just yet!
For more information on the topic please contact Lucinda Moylan.