4th March 2015 by John Lappin
The amount of tax relief you get on your pension has become an election issue. The two governing parties and the main Labour opposition are adopting very different approaches.
There has often been speculation that in these straitened economic and fiscal times the current Chancellor George Osborne would cut higher relief on pensions. Labour is apparently briefing that another ‘raid’ is due in the forthcoming budget. That would appear to go against most of the ministerial statements to date.
The lifetime limit and the annual limit which restrict pension saving in a different way, were cut in an early Coalition budgets. Those limits currently stand at a lifetime limit of £1.25 million and an annual limit of £40,000 though you can use unused relief from the previous three years to beef up that annual limit.
The Lib Dem pension minister Steve Webb wants to bring the higher rate relief down and the lower rates up to somewhere between 20 and 30%, though the party itself proposes putting this to review. The Lib Dems also want the lifetime limit brought down to £1m to fund an extra £1bn for the NHS though the pension minister is more open to removing the ceiling altogether. We may have to wait to see exactly what is on offer in their manifesto.
Labour as part of its promise to fund a cut in tuition fees, would first of all cut the tax rate for higher earners to 20% for their earnings above £150,000 as trade magazine the Actuary reported recently.
Any pension adviser will tell you that will make things very complicated in terms of pension planning for those concerned, but it is obviously a small minority directly affected.
But more importantly, it also proposes cutting the annual limit to £30,000 and the lifetime limit to £1m. This is still, mostly, out of the reach of many pension savers but it begins to have an impact on what might be termed middle Britain (at least the top of the middle) and indeed has been condemned as such by many commentators.
First, given that the new workplace reforms are aimed at getting young employees to save, and the earlier they start the better, is £1m such an unrealistic target over 40 years or so of saving and investing?
And does the £30,000 limit allow risk penalising those who might inherit money, or sell a share in a business and take that opportunity to supercharge their pension perhaps close to retirement? At Mindful Money, we think there is a definite risk of this.
We await the details, but a few other concerns come to mind. First as Old Mutual Wealth’s retirement expert Adrian Walker has pointed out, if the lifetime allowance is cut to £1m it will have been reduced by just over 45% in around five years, which rather runs contrary to encouraging people to save and invest for retirement.
It feels as if an element of aspiration has been taken out of pension savings at least for that top end of middle earners.
Translate this sort of sum into an annuity and it begins to demonstrate what a significant change this might be.
Hargreaves Lansdown’s head of pension research Tom McPhail points out that someone starting a pension at age 40, paying the maximum annual allowance of £30,000 a year wouldn’t even be likely to reach the lifetime allowance.
“In fact their projected pension fund at age 67 would be only just over £900,000, even after 27 years of saving,” he says.
Given it is the middle chunk of people by age who can often be ‘undersaved’ partly because they are in the less generous but increasingly common defined contribution pension, this may be another wrong signal to send.
McPhail suggests that restricting the lifetime allowance to £1 million would mean that a 65 year old looking to buy an inflation-linked income i.e. a joint life annuity for him or herself and a spouse could obtain a maximum income of £27,000 a year.
(This will vary somewhat as annuity prices change but is a very good guide).
Of course, in reality, annuities are going to be much less popular after the Freedom and Choice reforms. People have housing wealth at least usually and perhaps other investments and sources of income. Yet the idea of ensuring that pension investments are specifically used to fund retirement has also been somewhat undermined by the recent reforms. It should be viewed as a good thing for people and society. Would these reductions Labour government detract somewhat from the whole idea of pensions?
It also sets up another potential imbalance between defined contribution pensions and final salary – and usually public sector – arrangements where it may be possible to reach a £50,000 pension without falling foul of the system.
This could of course change under Labour’s plans, depending on how much DB benefit they allow to built up under various rather complicated calculations that would surely accompany the change.
Yet at Mindful Money, we would suggest that anything that causes more tension and friction between private and public sector pensions, and any further perception of favouritism should be avoided. Indeed, that might be something the remaining defined benefit scheme members really need to pay attention to as well.
It also feels that £27,000 for two retired people (if one is mostly funding the other person’s retirement) while significant, isn’t exactly fat cat territory. It might be something to aim for and beyond certainly if a pension investor is serious about getting close to what is known as replacement income.
It feels unlikely that we will see an opinion about such details from the other parties which may take a significant share of the vote i.e. UKIP and the Scottish Nationalists. The former may not get into such detail. In the case of the latter, it doesn’t clearly fall within the devolved powers, tuition fees are not levied in Scotland, although some of the potential tax changes are big enough to have an impact.
So we have, we think, three policy stances emerging, given the Tories still seem unlikely to change things. There is an election coming. At least you can always vote for the policy you prefer.