Pensions are the last bastion of tax relief for ordinary citizens – but the government is hinting that the lucrative breaks may be abolished in the next budget.
The problem with pensions is they are too expensive for the Treasury and the carrot of tax relief on contributions to reward retirement savers just isn’t working any more.
Fewer workers invest in pension now than 10 years ago – down to 38% of the workforce from 46% a decade back. A drop of around 18%.
Savers will have to wait until March 21 to find out whether the smoke and mirrors coming out of the Treasury are really what Chancellor George Osborne is planning, but it’s plain to see he can grab some apples bobbing in the barrel that will pay big bucks in savings for a cash-strapped nation.
So what are the rumours and where do they come from?
Government works by pulling the strings on a complex network of lobbyists and journalists.
Someone in the Treasury will brief a trusted media source with an off-the-record, unattributable story to test the water of public opinion. The journalist publishes the story and the government then looks at how much storm the story stirs up.
If the response is acceptable, the ‘leak’ often goes on to become policy.
These are the current leaks doing the rounds about pensions, which started with a briefing by Treasury secretary Danny Alexander in the Daily Telegraph on February 10:
Restricting pensions tax relief for higher rate taxpayers
This started as a way to tighten tax relief on 50% taxpayers and developed in to a cudgel to beat everyone paying tax above the basic rate of 20%.
The move affects 3 million people paying tax at 40% or above.
Total personal tax relief to all taxpayers is about £6.9 billion. HM Revenue & Customs reckons:
• 39% – £2.7 billion – goes to basic rate taxpayers, who receive 20p for every £1 invested in their pension fund
• 43% – £2.9 billion – goes to higher rate (40%) taxpayers, who receive 40p for every £1 invested in their pension fund
• 18% – £1.3 billion – goes to top rate (50%) taxpayers, who receive 50p for every £1 invested in their pension fund
Cutting tax relief to 20% across the board would save half of the relief to higher rate taxpayers and three-fifths of that to top rate tax payers – assuming they still receive basic rate relief.
That makes the total saving to the Treasury of around £2.23 billion every tax year.
Scrapping the 25% tax-free cash lump sum
HMRC reckons relief on pension lump sums adds up to £2.9 billion of ‘lost’ tax each financial year.
The idea is to give savers an option – take your money now but pay tax or keep the whole amount in your pension scheme to provide extra income.
That extra income could well be taxed as well, so the decision comes down to some smart maths at retirement time. The carrot here might be raising the tax thresholds for over 65s so they are rewarded for foregoing their tax-free lump sum.
Many over 55s count on the lump sum for paying down debts, buying a car or to fund that holiday of a lifetime or home improvements for a more comfortable retirement.
With an average pension fund of around £36,000 on retirement, that cash is worth about £9,000 to someone retiring.
With an annuity on the remaining fund paying out an average £1,400 per year, keeping that lump sum tied in with the rest of the fund could add another £466 a year to a pensioner’s income – over a typical 20-year retirement, that’s an extra £9,333.
Pensions dilemma for the Chancellor
The temptation for the Chancellor is an easy saving of up to £5 billion a year by tinkering with pension tax relief.
That’s a significant annual contribution to the government’s spending cut targets, slicing the required amount by around 25% every year.
Everyone knows paying pensions is a problem that is only likely to get worse as everyone is likely to live longer, spend a greater part of their lives in retirement and will need expensive long term care and nursing.
The trouble is no one wants to pay.
What he will do on Budget Day (March 21, 2012) is anyone’s guess, but he has already demonstrated pensions are not off limit with changes to the default retirement age. The age for receiving the state pension is also stretching further in to the distance for many over 55s.
Sending the wrong message
Pension providers, the government and other parties with a vested interest want to encourage everyone to save more.
For companies managing the savings, this represents profits from charges.
For the government, more savings represents less money flowing out of the Treasury.
Fiddling with pensions delivers a message the Chancellor wants to avoid, because how can anyone commit to a financial plan on the basis politicians will pull the rug out somewhere down the line?
