Rishi Sunak’s March 3rd benchmark will be overshadowed by the cost of building back Britain. Will pensioners be treated sympathetically and will those saving for a pension have to pay some of the price?
Thanks to Becky O’Connor, Head of Pensions and Savings at interactive investor, for much of this market intelligence. This blog provides a rundown of current pension allowances, tax relief and the state pension triple lock – suggesting possible changes and areas of concern.
What are they? The maximum amounts you can pay into a pension, without paying tax
Will the Chancellor announce changes on Budget day? Changes to pension allowances are unlikely. Since ‘A-Day’ pensions simplification in 2006, pension allowances have been significantly reduced to the point where many middle-income earners as well as higher income earners, can find themselves at risk of breaching the thresholds over which they are liable for tax charges. So further reductions to allowances, as pension contributions and pot sizes rise, would hit more people over time and would mean allowances could become an issue for the many not the few.”
Annual allowance (AA)
- Introduced in April 2006 (15-year anniversary in 2021) at £215,000.
- Increased steadily to reach £255,000 by 2010/11, reduced to £50,000 2011/12, then to £40,000 in April 2014.
- The annual allowance for contributions is £40,000. It covers the total contribution including an employer’s contributions in a defined contribution scheme and total benefits built up in a defined benefit scheme. Contributions above the AA can be liable for a tax charge, which effectively cancels out any tax relief
- May be able to bring forward unused annual allowance from previous three tax years
Money Purchase Annual Allowance (MPAA)
- The amount that people who have already started to access their pension can pay into it yearly. Introduced in April 2015 – was £10,000 per year
- Reduced to £4,000 a year from April 2017
- Not able to bring forward unused allowance from previous years
The MPAA is low for those who continue to work past the age they first access their pension – which is a lot of people. It restricts older workers’ ability to build up their pension further significantly. There is a good argument to increase it as more people work for longer but still want to access their tax-free cash at 55.
Tapered Annual Allowance
- Introduced in April 2016
- Annual allowance drops by £1 for every £2 adjusted income goes over £240,000
- Has a minimum of £4,000
- Applies if both your ‘threshold income’ is more than £200,000 (exc. Pension contributions) and your adjusted income is over £240,000 (inc. pension contributions)
- These limits were increased from £110,000 and £150,000 respectively in the 2020/21 tax year
- £1.073 million, with rises linked to CPI (due to rise to £1.078mn). This is the total amount in your lifetime you can have in your pension before a tax charge is due. It does not affect most people.
- Was £1.5mn when introduced in April 2006. Increased steadily to £1.8mn in 2010/11 before being reduced back down to £1.5mn in 2012, to £1.25mn in 2014 and reached £1mn in 2016/17. It has risen with inflation since.
- The Lifetime Allowance tax charge is 25% of any income taken or 55% of any lump sum.
In 2018, the Treasury Select Committee suggested replacing the Lifetime Allowance with a lower Annual Allowance. In its current form, the LTA may act as a disincentive to invest in pensions for those who think they might reach it. Such an amount is still only likely to deliver a comfortable retirement income rather than a lavish one – it’s less impressive than it sounds – and it would be good to encourage rather than discourage people from targeting this amount in their pension.
Private pensions: tax relief
What is it? It is what you would have paid in income tax if you had kept the money now rather than putting it in a pension for the future. The relief from tax is designed as a reward to invest in a pension. It’s an effective uplift to your contributions. Without it, pensions could become less attractive relative to other investments.
Basic rate taxpayer relief = 20% tax relief on pension contributions
Higher rate taxpayer relief = 40% tax relief on pension contributions
Additional rate taxpayer relief = 45% tax relief on pension contributions
Will the Chancellor announce changes on Budget day? This is an area considered ripe for reform but is unlikely this year, when complicated changes might feel poorly-timed. Allowances have been the focus of government policy change in recent years, rather than relief.
A flat rate of tax relief was proposed by the Treasury Select Committee in July 2018. The promotion of tax relief and its significant benefits to those who do not currently understand it and so are not incentivised by it, would be an essential part of plans to make this more generous for basic rate taxpayers. Reducing relief to higher earners is likely to act as a disincentive to invest as much in their pensions.
Non taxpayer/ low earner
- People who don’t pay income tax because they don’t earn, or earn less than the income tax personal allowance, can get tax relief on a maximum contribution of £2,880 (£3,600 including 20% tax relief) a year. However, someone in a net pay employer scheme who earns less than the £12,500 income tax personal allowance won’t have this tax relief added automatically.
The Government needs to fix the issue of people who are low earners on less than the £12,500 personal income tax allowance not receiving tax relief, if their employer operates a net pay scheme. They are missing out and many won’t even know. Reform is on the cards, although proposals might not be announced as soon as the Budget.
State pension: the ‘triple lock’
What is it? Guaranteed annual rises in the State Pension in line with wages, inflation or 2.5%, whichever is the higher. It was introduced in 2010.
Will there be changes on Budget day?
The ‘triple lock’ is costly to the Government but its removal could be potentially devastating for tomorrow’s pensioners, many of whom don’t yet know the extent to which they will depend on the state pension for retirement income. Millions of people depend on the state pension – many of these are women. It is not generous relative to other countries and while it seems generous compared to other working age benefits in the UK, those campaigning against its protection should be careful what they wish for.
Areas of concern
There are a number of groups who need more support with their pension provision. They are less likely to have any pension, or a big enough pension to avoid dependence on the state pension in retirement. These are:
- Self-employed people – there are around 5 million self-employed people in the UK and around half do not pay into a pension, according to Unbiased.co.uk.
- Women – there is a significant gender pension gap, particularly for mothers. Women either need greater state support in retirement or better incentives to pay into a pension, to make up for income and contributions lost during years out of work for childcare.
- Low income earners – People earning less than £12,500 paying into a work pension via net pay but not benefiting from tax relief on pension contributions
- People in certain regions – A survey for interactive investor found regional divides in private pension provision. It found that people in the North East, the East and West Midlands were the most likely to say they don’t have a pension, at 44%, 34% and 34% of respondents, respectively.
- Dependence on the state pension – More than 1 in 4, 3.4 million people, over the age of 65 (28%) don’t receive a full state pension, either under the basic state pension or the new state pension.* According to the FCA Financial Lives Survey 2021, among over 65s: 35% said state pension was main source of income. Women twice as likely to say this as men. For those who had accessed a DC pension in the last 4 years, 31% said the state pension was or was expected to be their main source of income, increasing to 51% of those who had encashed fully.
The need to boost the Treasury’s coffers now must not come at the expense of our future income in retirement.
As the working population becomes more dependent on defined contribution rather than defined benefit pensions, we will need all the incentives to contribute and grow our pensions as we can get.
The Chancellor must be mindful of this uncertain retirement outlook for today’s working age population and find ways to boost rather than diminish private pension provision, as the result of inadequate private retirement investing will be greater dependence on the State Pension and other state support for pensioners, such as Pension Credit.
Cutting any tax incentives either in the form of reliefs or allowances here would seem perverse – and so would removing protections around the state pension.
Possible policy changes that could boost private pension provision:
- Equalise basic and higher rate pension tax relief. Either by raising basic rate relief and reducing higher/ additional rate relief, or just reducing higher/ additional rate relief without raising basic rate relief. A possible blow to higher rate taxpayers, for whom 40% tax relief makes a big difference to contributions. Equally, if basic rate tax relief was raised slightly, while higher and additional rate relief was cut, this could be seen as a way to boost pension outcomes for the majority of UK taxpayers.
- Make NICs payable on income from employment for those over the state pension entitlement age (currently, retired people who work over the age of 65 do not have to pay NICs, giving them more take-home pay)
- Reduce the minimum age for auto-enrolment to 18. Around half of teenagers do not go to university. If young people start work and paying into a pension at 18 rather than 22, the current minimum age for auto-enrolment, this could boost their eventual pension pot by thousands of pounds.
- Reduce the £10,000 auto-enrolment threshold, perhaps to the qualifying earnings level of £6,240
- Increase minimum auto-enrolment salary percentage from 8% to 10% then to 15% gradually.
For more detail