Is it better to pre-empt potential pension tax relief changes or wait to see what the Chancellor decides? Les Cameron weighs the options
Potential changes to the current tax relief system for pension contributions have been widely reported, with most predicting a move to a flat rate of somewhere between 25% and 33%
If this is the case, at some point in the future, basic rate taxpayers could enjoy an increased incentive to save into a pension and the benefit to higher and additional rate taxpayers will be reduced.
However, the devil will be in the detail and the mechanism for providing tax relief may have a wider financial impact than the change of rate itself.
There appear to be two main methods of applying a rate of relief that is different from underlying tax rates, these are:
• ‘Tax relief at source' - tax relief applied to pension contributions at source, with the pension holder paying the net contribution and the tax-relief (at whatever rate) being reclaimed directly by the pension provider, or
• ‘Tax reducer' - pension contributions paid gross by the pension holder and the tax relief applied as a ‘tax reducer'.
Both methods have current precedents and both could have ramifications beyond the rate of relief itself.
Potential implications
If the ‘tax relief at source' method is used, does this mean that payment of pension contributions under a ‘net pay arrangement', as applied by most company pension schemes is at an end?
Will this mean that the government will allow a greater amount of tax relief to be granted on pension contributions than the level of tax actually being paid by the individual? This has a precedent in that non-earners are currently eligible to receive basic rate tax relief on their pension contributions at source, up to a maximum gross contribution of £3,600 per annum.
And in this instance, what would become of salary sacrifice? This effectively gives full marginal rate tax relief on the pension contribution. Will something have to happen here - perhaps a "benefit in kind" charge?
If the ‘tax reducer' method, currently used for enterprise investment schemes and venture capital trusts, is used, then this would limit the level of pension contributions that could be paid, by reference to the level of tax being paid by the individual client.
This could severely limit contributions by lower earners, the very group of people the headline increase in the rate of tax relief would appear to benefit.
The level of future pension contributions may therefore not only be limited by relevant earnings, annual allowance, tapered annual allowance, money purchase annual allowance, but also the level of income tax payable by the individual.
Or perhaps limiting the amount of tax relief on pensions to the level of tax being paid negates the need for all these separate limits. If this is the case perhaps this could open the gate to higher levels of pension contributions for higher earners, albeit at a slightly lower rate of tax relief.
It is less likely that a "tax reducer" approach would be pursued as it would be against the policy of encouraging lower earners to save and presumably be detrimental to auto-enrolment, the home of lower earners making pension contributions.
Whatever the method the government adopts, it appears that the ability to use pension contributions to ‘manage' adjusted net income (ANI) could come to an end.
Removal of the ability to manage ANI means that those subject to the child benefit tax charge will feel the full brunt of up to 70% plus effective tax rate and/or an effective 60% income tax rate for those with a reduced personal allowance, without the management tool provided by pension contributions.
There is also the additional complication of getting something that works for both relief at source and net pay arrangement. Or will we see a differing relief treatment dependent on the type of arrangement?
According to the Treasury, no decision has yet been made on whether or how to reform the system and all options are still being considered.
Failing to take full advantage, or even waiting to see what happens in the Spring Budget on the 16 March 2016, could turn out to be a source of regret
Planning in the meantime
So, on this basis, there's a chance that nothing might change. But how should clients plan in the meantime?
According to current speculation, there would be a 12-month delay in the implementation of any change and, given the complexities, this would appear likely.
However, time may still be of the essence.
It is possible, some would say very likely, that given the potential time lag before implementation, the Budget on 16 March will include some form of anti-forestalling legislation. This could immediately limit the opportunity to pre-empt the change.
Therefore, it would appear to make sense for higher and additional rate taxpayers to take maximum advantage of available pension contributions while the higher rates of relief remain, and they would perhaps be wise to do this before the 16 March 2016.
For basic rate taxpayers, the decision is slightly less obvious. Do they defer contributions until the assumed increased level of relief is introduced? On the surface, basic rate taxpayers delaying contributions may appear to make sense.
However, if the ‘tax reducer' method is used to provide relief, they may find that by waiting they have further restricted the amount of pension contributions they can make. The question here is whether it is worth taking the risk for a potential 5% extra tax relief?
Alternatively, it seems unlikely that any anti-forestalling legislation would prevent basic rate taxpayers from receiving basic rate tax relief so a ‘wait and see' approach could be viewed as relatively low risk, with plenty of time post-Budget to make 2015/16 contributions.
All of the above remains unknown for now so as always it is better to focus on what we do know.
And what we do know is that for the vast majority of people, especially those eligible for higher rates of relief, pension contributions currently represent fantastic value for money.
Given the fact that the focus of the government's review appears to be reducing the cost of providing tax relief, failing to take full advantage, or even waiting to see what happens in the Spring Budget on the 16 March 2016, could turn out to be a source of regret.
Les Cameron is head of technical at Prudential UK & Europe
