16th June 2015
High earners are being urged to make the most of the valuable pension tax relief afforded by the lifetime allowancee ahead of a potential clampdown in the new Government’s Budget on July 8.
Hargreaves Lansdown has warned that 45% taxpayers are set to be targeted with restrictions to their Annual Allowance, but there is an opportunity to act ahead of the Budget and get up to £13,500 more relief. The changes are set to lead to a 67.5% effective tax charge for top earners.
In their pre-election manifesto, the Conservative party promised that if re-elected they would restrict pension contribution allowances for those earning over £150,000. They plan to do this by progressively reducing the Annual Allowance at a rate of £1 for every £2 earned over £150,000, meaning that once someone’s income went above £210,000, they would have an Annual Allowance of just £10,000.
There are mounting fears that the Chancellor could announce further details of this restriction to the Annual Allowance on Budget day, with the possibility it could take effect the same day. With the Budget now only a few weeks away, higher earners who are currently eligible to contribute up to £40,000 and secure 45% tax relief are encouraged to act now or risk missing out.
The potential cost to someone earning £210,000 or more could be £13,500 in lost tax relief (45% of £30,000).
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “Right now, anyone earning over £150,000 who is planning on making pension contributions this year should give serious consideration to making their investment ahead of the Budget, just in case the Chancellor brings down the shutters on July 8.”
Any higher earner who wants to calculate their pension contribution and tax relief entitlements can do so using this pension calculator https://www.hl.co.uk/pensions/interactive-calculators/pension-tax-relief-reduction
The previous Government also announced in its last Budget in March 2015 that it planned to reduce the Lifetime Allowance (LTA) to £1 million.
McPhail adds: “The LTA has become a cap on aspiration for millions of middle-earners and should have no place in the pension system.”
“We would prefer the government to leave pensions alone for a while, but if the government does intend to make further reforms to pension taxation, they should look at scrapping tax relief altogether in favour of a flat rate incentive of 33%, which could be promoted on a simple ‘buy 2, get one free’ basis, together with the abolition of the LTA.”
Problems with restricting the Annual Allowance for top earners
There are a number of potential problems with the government’s proposed plans to restrict pension tax relief for higher earners, Hargreaves Lansdown argues.
It says that probably the single biggest problem is that an individual will often not know until near (or even after) the end of the tax year how much they have earned in the current year. This in turn means that they cannot plan their pension funding, or whether to stay in their employer’s auto-enrolment scheme. After the end of the tax year they may find themselves hit retrospectively by a hefty tax bill in respect of their pension membership, as a result of earning over £150,000.
The cost of communicating this kind of complexity to investors puts upward pressure on pension costs.
Individuals whose earnings increase above £150,000 would face a double whammy; every £2 they earned up to £210,000 would potentially cost them not just £0.90 in tax, it would also cause them to lose £1 of pension contribution allowance, resulting in the loss of a further £0.45 in possible tax relief. Therefore the effective tax rate on earnings in this band could be 67.5%.