MANY pension savers face an unexpected tax bill as new government measures targeting high earners threaten to also hit public sector employees who are on more modest incomes.
Cuts in the tax relief available on annual pension contributions and in the amount that can be saved tax-free into a pension over a lifetime will hit hundreds of thousands of workers, the government’s figures show.
The government hopes the move will create a perception that the wealthy have to pay their fair share as its austerity regime continues. But experts have warned that middle income savers will also be caught up by restrictions, announced in Wednesday’s Autumn Statement. The main measure, which had been widely predicted, was a cut from £50,000 to £40,000 in the amount that can be paid into a pension each year and still receive tax relief, taking effect in 2014. It follows a reduction from £255,000 that was announced in 2010.
Andrew Tully, pensions technical director at MGM Advantage, said: “It appears no government can resist this seemingly easy option. And it raises the spectre of further cuts in future any time the government need to raise some funds.”
Yet few expected the chancellor to resist a change that saves the government an estimated £600 million. The good news for those affected is that they will be able to carry forward their allowance at the £50,000 level. Adrian Walker, pensions expert at Skandia, said: “By delaying the reduction until the 2014-15 tax year and by retaining the higher annual allowance for carry forward planning for earlier years, the chancellor has provided an opportunity for many to maximise funding opportunities over the next 15 months using the current thresholds.”
However the cut in the lifetime allowance will claim more victims, including up to 5 per cent of public sector workers. Around 340,000 workers will be affected, compared with the 160,000 likely to be caught by the annual tax relief reduction, Treasury figures show.
The allowance, which is the maximum that can be saved tax-free into a pension over a lifetime, will fall from £1.5m to £1.25m in April 2014. Any excess above the cap where no protection has been arranged – more on that later – is taxed at 55 per cent.
For instance, someone retiring with a £1.3m pension fund will be charged tax at 55 per cent on the £50,000 above the limit that is taken as a lump sum (a tax charge of £27,500).
The lower lifetime allowance will particularly affect public sector workers who continue to benefit from generous final salary (defined benefit) pension schemes, which are in danger of becoming extinct in the private sector.
The concern is that the allowance, having previously been slashed from £1.6m, will fall further over the coming years, with inflation helping to drag more people into a tax net they hadn’t seen coming.
Joanne Segars, chief executive of the National Association of Pension Funds, said: “Osborne claims he is taking a carrot away from the rich, but he is also beating many middle class savers with a stick. Middle managers in the public and private sectors will get caught in the net.”
Skandia also warned that the reduced lifetime allowance would hit not only the wealthy, but “ordinary hard working, prudent savers” too.
It used the example of someone first saving into a pension at 25, with the aim of retiring at 65 with 40 years of contributions under their belt. They would have to pay just £427 a month into their pension (£256.20 and £341.60 net for higher and basic rate taxpayers respectively) for their savings to hit the £1.25m limit by the time they reach retirement (assuming 3 per cent a year contributions growth and annualised investment growth of 7 per cent).
Under the current allowance it would taken a £511 gross monthly contribution to breach the limit (using the same criteria).
Stephen Green, a senior consultant at Towers Watson, warned that some of those in danger of hitting the allowance – triggering a tax charge in the process – would simply stop saving.
He said: “Unlike the annual allowance cut, a lower lifetime allowance and the proposed protection system will stop some high earners from contributing to pensions altogether and make much more of their income taxable now rather than when they retire.”
The system to which Green referred is the fixed protection for which investors can apply if they expect to be caught by the new £1.25m allowance. The protection, which allows investors to retain the current £1.5m limit, is available provided they are in a final salary scheme and cease to build up benefits, or they’re in a defined contribution scheme (as most private sector pension savers are) and make no further pension contributions.
There was good news for some pension savers, however, as the chancellor heeded calls to increase the amount of income that can be taken each year by those in capped drawdown.
The maximum annual income from drawdown – where the fund is left invested at retirement and income taken out in tranches – was cut last year from 120 per cent of the equivalent annuity to 100 per cent. The aim was to prevent retirees from eating into their savings too quickly, but the change, combined with plunging gilt yields, has resulted in some retirees seeing their income slashed by more than half.
Osborne has now responded by returning the income maximum to the previous limit of 120 per cent of the government actuary’s department rate.
Alastair Black, head of customer income at Standard Life said: “We need to wait for the details, but the changes proposed will make a real difference and give drawdown users a fairer deal, but more still needs to be done.”