It seems as though the chancellor is giving with one hand and taking with the other…
In 2015 the government implemented its plans to give you unprecedented pension freedoms. For the first time, you were given near total control over when and how you withdraw money from your pension fund after age 55.
And there will be even more changes introduced in 2016.
However, the party mood isn’t likely to be as jovial.
If you’re a higher earner, it certainly looks as though saving for your retirement will get a whole lot harder come 6 April.
Here’s a quick roundup of the rules that are definitely changing together with those other changes which the pundits expect to be announced on Budget day.
First let’s look at the definites.
1. Reduction in Lifetime allowance
If the nominal value of all of your pension benefits exceeds the lifetime allowance, you’ll need to pay a tax charge of 25% on any excess if it is withdrawn as an income (e.g. from an annuity or drawdown) or 55% if it is withdrawn as a cash lump sum.
Currently the allowance is set at £1.25m but it will fall to £1m from the new tax year. This may sound a lot of money and you may not think that your pension will ever get anywhere near that value. But higher earners with generous “Defined Benefit” pension schemes may be surprised to find the value of their pension reaching the threshold as they approach retirement.
Action: If your benefits already exceed the new limit, it may be vital that you consider taking your pension before April 2016 or applying for individual protection to avoid the impact of this reduction.
2. Annual Allowance falling
Currently you can claim tax relief at your marginal rate on any contributions you make to a pension up to the annual allowance of £40,000 or 100% of your income, whichever is the lower.
From April this year, the annual allowance will be reduced by £1 for each £2 you earn over £150,000 and will taper down to £10,000 which is the new annual allowance for higher earners.
Note that the £150,000 threshold is an “adjusted income” and includes income from dividends, interest on savings and may also include employer pension contributions. The change could therefore capture you even if you don’t get paid as much as £150,000.
Action: You should confirm whether your adjusted income exceeds this threshold and, if it does, consider making additional pension contributions this year.[Note: If you need some help understanding how these changes will effect your pension and the tax you pay, request a free 15-minute consultation with me on the telephone.]
3. Harmonisation of Pension Input Periods
A Pension Input Period (PIP) is the year during which people use up their individual annual allowance. At present, PIPs can start on any day of the year, and vary from person to person. From 6 April all PIPs will be harmonised to start on the first day of the tax year.
“The Government is trying to create a uniform pension input period for everyone, and to do this has pressed ‘reset’ on the old one” Tony Harris, Old Mutual Wealth.
As part of its transitionary arrangements the government has created an additional input period running from 8 July 2015 to 6 April 2016. This means that anyone who contributed into a pension during their PIP that finished sometime between 6 April and 8 July 2015 has got a chance to “double up” and put a further £40,000 into their pension before 6 April 2016.
A 45 percent tax-payer using the full £40,000 allowance would benefit from £18,000 in tax relief in this extra period.
Action: If you’re a higher rate tax payer and have the funds available; consider taking advantage of this opportunity to double up by making extra contributions before the new cuts are introduced.
4. Contracted-Out Arrangements to End
At present, many defined benefit scheme members pay a less National Insurance because they are “contracted out” of the second state pension.
This arrangement will finish in April when the new Single Tier State Pension is introduced. Anyone paying into a scheme that is contracted out will see their National Insurance contributions increase by 1.8 percent.
Employers’ contributions will also rise and many expect to see benefits reduced to compensate for the extra costs.
And now those changes that aren’t yet confirmed…
5. Tax Relief on Pension Contributions
Whilst the government has not yet announced the outcome of its consultation announced in July 2015, it’s broadly expected that the chancellor will target savings from the tax relief provided on pension contributions. This giveaway currently costs the government £50 billion a year, so the motivation to make a change is considerable.
It’s likely that the relief will be restricted, or even stopped altogether.
Instead of receiving tax relief at your marginal rate, you might only receive relief at a flat rate. David Smith at Tilney Bestinvest, said he expected tax relief to be reduced to 25 percent. Others suggest that a rate of 30 percent is more likely.
“The worst case scenario will be the complete abolition of pension tax relief, with pensions in effect replaced with a ‘Pensions ISA’. It’s feasible, as the saving to the Government would be gargantuan.” David Smith, Tinley Bestinvest
On this basis, workers paying tax at 40 percent would therefore see their relief on £20,000 in pension contributions falling by at least £2,000.
The chancellor may impose these changes with immediate effect when he presents his budget in March so you may not get any notice.
Action: Consider therefore whether you should take advantage of the marginal rates available to you today by making extra contributions ahead of the budget.
6. Tax on Employers Pension Contributions
Employers’ contributions to pension schemes may also come under fire in March’s budget.
The issue here is that the introduction of a flat rate of tax relief on pension contributions will encourage employees to seek salary sacrifice arrangements to secure tax relief by the back door. Under such arrangements, the employer increases its contributions into a pension in return for the employee taking a lower wage.
“If the Chancellor opts for a flat rate on employee pension contributions, he will almost certainly make changes to company contributions for higher and additional-rate taxpayers,” Steven Cameron, Aegon.
Currently, contributions made in this way are free from national insurance and income tax.
Making these taxable for higher and high rate tax-payers will remove this incentive.
Action: If you’re expecting to be hit by the flat rate pension tax relief, you might want to consider making additional contributions up to the maximum allowable before the budget.
The information provided in this article does not constitute a personal recommendation for any product or service. Pensions are a long term commitment. You may not be able to access you pension funds until the age of 55. Investments can go down as well as up and you might not get back your initial capital. Pension and tax legislation does and can change in the future which could impact your pension[Note: Request a free 15-minute consultation with me help understanding how these changes will effect your pension and the tax you pay.]