A surprise change of Chancellor has not halted speculation about a £10billion raid on pension tax breaks for higher earners.
This could see Government top-ups into retirement savings pots lowered to the 20 per cent basic rate for everyone.
Now, financial experts are warning people who get higher top-ups because they pay a 40 per cent rate of tax to put whatever they can afford into their pensions, just in case of a major shake-up in the Budget.
New Chancellor: Rishi Sunak is likely to have received the appointment on condition he takes direction from Number 10
We look at how likely this is to happen, and explain how much you can put into your pension and the advantages and potential pitfalls below.
What could be in next month’s Budget now Britain has a new Chancellor? We look at how Rishi Sunak’s to-do list could affect you here.
How probable is a pension tax relief overhaul?
After Sajid Javid dramatically quit last week, rookie Chancellor Rishi Sunak was given just a month to prepare for the Budget on March 11.
He is likely to have received the appointment on condition he takes direction from Number 10, which means Prime Minister Boris Johnson and his powerful political strategist Dominic Cummings are in charge.
Should pension tax relief be hacked back to a flat 20 per cent?
This is Money’s Editor, Simon Lambert, argues it would mean an even worse deal between the generations on pensions. Read more here.
Cummings is a notorious contrarian, but it’s unclear how hard he will want to hit the better off and provoke an inevitable backlash from traditional Tory voters.
The next election might be years away, but that’s time for the effects of lower contributions into pensions to make themselves properly felt in people’s retirement pots.
Having a smaller pension will still be a present day concern, not a long distant memory.
While we wait to find out which way they jump, pension experts suggest savers might be better off safe than sorry in topping up their retirement savings if they can, to get the full whack of Government cash into their pots while it’s still available.
It’s worth noting that ahead of previous Budgets, similar rumours of a pension overhaul have led to a big rush of money going into pots.
And that’s landed the Treasury with a temporary but large extra tax relief bill – even though the Government’s mooted money-raising reforms never actually materialised to offset this cost.
Will pension tax relief get the chop in the Budget? Listen to the This is Money team discuss this in our latest podcast.
Should you top up your pension now?
‘Sajid Javid’s resignation raised uncertainty over whether the Government would throw its fiscal rules out and cut taxes while spending more, but Rishi Sunak has committed to delivering on promises around “levelling up”, which would seem to support the idea of tax rises for the wealthy or higher earners,’ says Sarah Coles, personal finance analyst at Hargreaves Lansdown.
‘There’s a real risk of a major tax raid in the Budget.
‘It’s not just because the unwritten rule of electioneering is to announce the spending increases during campaigning, and wait for your first post-election Budget to reveal the bad news about tax.
‘It’s also because the Government has already said this is exactly what it plans to do – with a manifesto pledge to get rid of “arbitrary tax advantages” for the wealthy.
‘We don’t know exactly what form this raid will take at this stage, so the best way to help protect yourself from its impact is to take as much advantage as you can of the current tax breaks – while they still last.’
‘Each year most people have a pension allowance of £40,000 or their total earnings – whichever is lower. Even non-earners have an allowance of £3,600. It means you can contribute tax-efficiently to a pension on behalf of a non-working spouse or a child too.’
Powerful Number 10 adviser: Dominic Cummings is a notorious contrarian, but it’s unclear how hard he will want to hit the better off and provoke a backlash from traditional Tory voters
Coles also suggests taking advantage of ‘salary sacrifice’ if your employer offers this option.
Salary sacrifice, where staff and employers boost pension payments in order to cut their National Insurance payments, might be a casualty of a shake-up in tax relief, because the Government would probably want to close this loophole.
‘In some cases, the government will let you give up a portion of your salary, and spend it on certain things free of tax (and sometimes National Insurance),’ explains Coles.
‘This includes pensions, childcare vouchers, bike-to-work schemes, and technology schemes. It can be a great way to cut your tax bill.’
Gary Smith, chartered financial planner at Tilney, says: ‘According to HMRC forecasts, pension tax relief is expected to cost around £40billion this year, with the biggest beneficiaries being higher rate tax payers.
‘The future of higher rate relief on pension contributions has been in doubt since former Chancellor George Osborne ordered a Treasury consultation in 2015 but backed down on an overhaul.
‘While the current system of tax reliefs may yet survive the latest threat, their continuation cannot be taken for granted and therefore higher earners who are in a position to do should consider maximising pension contributions in advance of any potential changes.
‘While the annual pension allowance for most people is a gross amount of up to £40,000 – meaning the net cost for a 40 per cent tax payer is just £24,000 – those who have already maximised their current year allowance can also mop up any unutilised allowances for the three previous years, under “carry forward” rules.’
How much extra should you put in your pension?
If you are a basic or higher rate taxpayer, there’s a cap of £40,000 known as the annual allowance on how much you can put into a pension each year and still get tax relief.
The cap includes the tax relief itself, so you have to factor that into the £40,000.
Also, the annual allowance cap has to correspond with your earnings in any particular year, meaning it will be reduced in line with your income if that is less than £40,000.
For an additional rate taxpayer, the annual allowance cap is gradually reduced on a sliding scale from £40,000 to £10,000 for those making between £150,000 and £210,000 a year.
But higher earners can be affected when pay reaches £110,000 because of the way pension rights are calculated, and these are especially difficult for workers to keep track of in salary-related schemes like the NHS one.
It is one of the issues that has affected doctors, who work unpredictable overtime shifts to reduce waiting lists and find it hard to work out how close they are to the £110,000 threshold – prompting them to turn down work for fear of shock bills.
Savers are currently allowed to roll over unused annual allowances for the past three years, on top of their annual allowance in the current year.
What happens if your pension payments breach annual or lifetime limits?
If you put more than £40,000 in a year into your pension, you won’t get any tax relief on any amount above that limit.
If your employer does it on your behalf, it has to levy your usual income tax rate on anything above the limit.
The lifetime allowance is not a limit on how much can be paid into a pension, as savers can continue paying in above it. Any gains you make from investment growth over the years will count towards it.
If you go over the limit, hefty tax charges will be levied when you retire. Any money above the level taken as income incurs an extra 25 per cent charge and as a lump sum it incurs a 55 per cent charge – this comes on top of normal income tax.
This effectively makes paying into a pension above the lifetime allowance uneconomical, as any benefits built up are heavily penalised.
So if your annual allowance is £40,000, you can play catch up with earlier contributions up to £160,000. You must use up all this year’s allowance first, before you exploit previous ones.
But you also have to watch out if your pot is close to the lifetime allowance, which is the total amount you can pay into a pension and still get tax relief.
The lifetime allowance is £1,055,000 in the current tax year, and is due to rise to £1,073,000 from April.
How does ‘carry forward’ work, and what are the pitfalls?
Savers can ‘carry forward’ any unused pension allowances from the previous three tax years once they have first fully used the current year’s allowance, explains Gary Smith of Tilney.
‘Allowances from the oldest year are used up first and at the end of every tax year, the “oldest year” falls away. Therefore, any allowances not used from the oldest year – now 2016/17 – will be lost for good if they are not carried forward.
‘To get tax relief on pension contributions that you make yourself, you need to ensure that the payments made in any tax year do not exceed earnings in that year.
‘An employer is not restricted by an individual’s earnings so they are able to pay in higher sums on occasion.’
Smith says carry forward can be useful to people in the following situations.
– Those looking to catch up on pension contributions because they are underfunded or because their financial position has improved and they are now in a position to do so.
– People whose current year pension contributions are now restricted by the tapered allowance because they have a total income over £150,000, especially if their earnings in previous years were below this threshold.
– Savers looking at retirement planning as maximising a pension can potentially remove funds from your estate for inheritance tax purposes and gives options to pass on wealth to your heirs in a very tax efficient way.
Threat to tax breaks: Pension experts suggest savers might be better off safe than sorry in topping up their retirement savings now if they can
But Smith warns that with the lifetime allowance at £1.055million, care needs to be taken to ensure that contributions and growth in your investments won’t take you over this limit.
He urges people to considering carry forward to seek advice from a financial planner.
Will pension tax overhaul be scuppered by final salary pension snags?
Defined contribution and final salary – known in industry jargon as ‘defined benefit’ – pensions work in different ways, and it would be much harder to apply a 20 per cent flat rate to the latter.
Steven Cameron, pensions director at Aegon, says: ‘In defined contribution schemes, what people get back is based on their contributions so a lower top up would reduce their future pension and may discourage some from saving through pensions.
STEVE WEBB ANSWERS YOUR PENSION QUESTIONS
‘The implications for defined benefit pensions are far less clear. Here, the individual is promised a certain pension at retirement.
‘Their contributions are fixed, tax relief top ups are paid to the scheme and the employer pays whatever extra is needed to balance the funding of promised benefits across the membership.
‘If the Government cuts the top ups for higher rate taxpayers, either the members will have to pay more or the employer will have even greater balancing contributions.
‘Neither will be welcomed so this could be yet another prompt to close the few remaining “gold plated” defined benefit pensions in the private sector.
‘There is also the risk that higher rate tax employees would face a “benefit in kind” tax charge on employer contributions.
‘While there are few remaining in the private sector defined benefit schemes remain common in the public sector. Any changes to tax treatment of pensions would need to apply here too to avoid divisive preferential treatment for public sector employees.
‘So the government will face explaining significant contribution increases for public sector higher rate tax payers or finding additional funds from public sector employers which ultimately may have to be paid for by general taxpayers.’
Gary Smith of Tilney has also previously highlighted the challenges of changing pension tax relief rules for final salary schemes.
He said: In contemplating such as move, the Government needs to give careful consideration as to how this might impact public sector professionals, especially doctors working in the NHS, where previous tinkering with pension taxation has caused chaos.
‘I would be interested to know how the removal of the higher rate pensions tax relief could be applied to public sector pension scheme members, as their pension contributions are currently deducted from gross salary before income tax is calculated, thus they automatically receive high rate relief.
‘If they were to alter this, it would increase the tax liability for NHS workers, which could actually make the current crisis even worse.
‘However, if the Chancellor doesn’t alter public sector schemes, this potential reduction in pension tax relief might only apply to private sector workers, which would be grossly unfair.’
TOP SIPPS FOR DIY PENSION INVESTORS
Some links in this article may be affiliate links. If you click on them we may earn a small commission. That helps us fund This Is Money, and keep it free to use. We do not write articles to promote products. We do not allow any commercial relationship to affect our editorial independence.