Speculation about pension tax relief is as much a sign of an upcoming Budget as returning swallows herald the arrival of spring (I’ve indulged in it myself).
But it’s understandable that people might think that the Chancellor would turn to pension tax relief to fill a potential Budget shortfall, his predecessor made quite a habit of it.
Current pension tax relief system
Pension contributions are generally paid before tax and hence usually benefit from tax relief at the marginal rate of tax (generally 20% or 40% of the contribution).
The total tax relief that can be received is restricted in two ways:
- The Lifetime Allowance (LTA) puts a limit on the total amount of benefits that can be built up in pension schemes over a person’s lifetime without triggering a tax charge.
- The Annual Allowance (AA) is a limit on the amount of pension that can be built up in a single tax year while still receiving tax relief.
If the LTA or AA are reduced, then tax relief will be restricted as a result of a direct tax charge or through the behavioural effect of people not making pension contributions in the first place. Reducing the LTA or AA tends to impact higher earners with good pension provision.
Past raids on pension tax relief
A quick reminder of the main ways that pension tax relief has been “raided” in recent years:
- Budget 2011
The LTA was reduced from £1.8m to £1.5m.
The AA was reduced from £255,000 to £50,000.
These measures saved about £4bn in 2018/19.
- Autumn Statement 2012
The LTA was reduced from £1.5m to £1.25m.
The AA was reduced from £50,000 to £40,000.
These measures saved about £1bn in 2018/19.
- Budget 2015
The LTA was reduced from £1.25m to £1m.
This measure saved about £0.5bn in 2018/19.
- Summer Post-Election Budget 2015
Tapered AA for people earning over £150,000 (reducing AA from £40,000 to £10,000 for this group).
This measure saved about £1bn in 2018/19.
Overall impact of past raids on pension tax relief
While the current Chancellor has conducted far fewer raids on pension tax relief, the cumulative effect of the recent changes to these rules has still cost taxpayers about £6.5bn this year.
By way of comparison, the Financial Times recently reported that restrictions on tax relief delivered £250m. The discrepancy between the reported receipts and the originally estimated impact of the changes is probably due to the fact that restrictions to tax relief work in two main ways: creating a disincentive to contribute to a pension scheme in the first place as well as a direct tax charge for exceeding the LTA or AA (HMRC data will only capture the latter).
Basis for current speculation about pension tax relief
It’s not too difficult to see the attraction of further restricting pension tax relief to any Chancellor at Budget time.
For this particular Budget, the Chancellor has to balance the Prime Minister’s promised cash boost for the NHS and other spending commitments with less-than-stellar public finances and tight fiscal rules.
A range of tax moves will have to be considered to get the Chancellor out of this difficult position.
A recent report from the Financial Times explained the position very succinctly and pointed out that “nothing is off the table”.
The Daily Telegraph recently predicted that pension tax relief will be cut to help pay for the NHS spending commitment.
Restricting pension tax relief is particularly attractive because it is far stealthier than more obvious changes to the main tax limits or rates.
How could pension tax relief be restricted in this Budget?
There are a number of different ways for the Chancellor to restrict pension tax relief. Anyone interested in the detail can read this comprehensive analysis by Willis Towers Watson.
Approaches can generally be characterised as either fundamental reforms or adjustments to the current system.
- Fundamental reforms
Making the tax-free pension lump sum fully or partially taxable would be a fundament reform but it is highly unlikely.
A single rate of tax relief at, say, 25%, instead of tax relief at the marginal rate of tax (mainly 20% or 40%) would be another fundamental reform. There was speculation about flat rate relief in the Times that month.
This was considered as part of a wide-ranging review after the 2015 general election but eventually dropped (reportedly as a result of pressure from backbench MPs). In a recent response to a report by the Treasury Committee the government reiterated its view that there is “no clear consensus” for any fundamental reform.
- Adjustments to the current system
As the analysis above shows - previous governments have shown a huge appetite for raising revenue through restricting pension tax relief.
Further restrictions to elements of the current pension tax relief regime seem by far the most likely way for government to seek to boost public finances through pension tax changes in Budget 2018.
Three options seem more likely than others. The section below shows how they might affect Prospect members. This is not an exhaustive list of all the ways that pension tax relief could be restricted, but it does cover the main measures previously implemented.
Detail on options for restricting pension tax relief
As noted above, three main options have been tried in the past:
- Reduce the LTA
The LTA was previously reduced from £1.8m to £1m. The previous Chancellor committed to uprating it in line with inflation after those reductions but a further reduction would raise more money.
If the LTA was reduced to, say, £750,000, many Prospect members earning about £80,000 a year or more would be likely to be impacted after a long career in a good pension scheme.
- Reduce the trigger for the tapered AA
Currently the AA of £40,000 is reduced for anyone earning more than £150,000 (it is reduced to £10,000 for anyone earning more than £210,000).
However the earnings trigger for the tapered AA includes the value of pension provision and can actually apply to people whose earnings are more than £110,000, once pension provision is allowed for.
Reducing the earnings trigger for the tapered AA to, say, £125,000 would affect many Prospect members earning about £80,000 a year or more.
- Reduce the AA
The AA has been reduced from £255,000 to £40,000 (and even lower in some cases).
If the AA was reduced to say, £20,000, a Prospect member in the civil service facing below inflation pay rises would have an AA tax charge every year if they earned £55,000 or more.
A civil servant enjoying a modest real terms pay rise could be potentially impacted by a reduction in AA of this level - even if they earned less than £40,000.
What can we do?
Sometimes reading pre-Budget speculation about what the Chancellor might do to Prospect members through different tax measures is a rather passive activity.
However previous speculation about changes to pension tax relief was stopped in its tracks because of backbench MPs’ concerns that it would alienate keys parts of their electorate.
There is certainly nothing to be lost from writing to your MP about any concerns you have about potential changes to pension tax relief – obviously this will be particularly effective if your MP is a Conservative or from the DUP.
It is easy to find your MP’s contact details from the Parliament website.
An email in your own words about your concerns about the impact of potential changes would be the most effective. However it could also be useful to cover some of the following general points:
- The cumulative impact of previous restrictions to pension tax relief since 2010 is running at £6.5bn a year already and there really are no further easy gains left from this source.
- When the Labour party proposed restricting pension tax relief to pay for a pledge to cut tuition fees, the then Chancellor (George Osborne) said that policy “involves penalising moderately paid long-serving public servants, including police officers, teachers and nurses”.
- Restricting pension tax relief is no longer a way of targeting very high earners - but could potentially impact people earning less than £40,000 in certain circumstances.
After the Budget
After the Budget you can check Prospect’s library for an updated version of our member’s briefing note on pension tax relief for information on how any changes might affect you.
Prospect members can also email us to register their interest in participating in a teleconference explaining how restrictions on pension tax relief for higher earners work (there will be an opportunity for members to ask questions at the end). The teleconference will be held at 3pm on November 8 (a recording will also be made available for members who cannot make this time).