Higher-rate tax relief on pension contributions for those earning more than £150,000 a year will be restricted from April 2011.
In his Budget speech, Chancellor Alastair Darling announced that the 40% higher rate of tax relief will gradually taper down to the basic rate of 20% for those on incomes over £180,000. The restriction applies to all contributions, but employers will continue to receive full relief on their contributions into employees’ pension through corporation tax and national insurance contributions.
Darling said: “I intend to address an anomaly which sees a tiny proportion at the top take a large slice of the help we give people to help them save. It is difficult to justify that a quarter of all the money the country spends on tax relief on pensions goes as to the top 1.5% of earners. I believe it is fair that those who have gained the most should contribute more.”
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Legislation will be introduced in the Finance Bill 2009 to prevent those potentially affected from seeking to forestall this change by increasing their pensions savings in excess of their normal pattern, prior to the restriction coming into effect.
Individuals who increase their pension savings on, or after, the date of the proposed change over and above their normal pattern of regular pension savings will be affected only if their total pension savings in that year are over £20,000.
Clive Grimley, partner at Barnett Waddingham, said the move will not affect new contracts of employment for higher earners, but it will apply higher taxes and limit tax relief on pension contributions of current highly-paid employees. “It will prevent those employees gaining the tax advantages offered by sacrificing salary or bonus in favour of a higher employer paid pension contribution. Politically this may be a good time to restrict higher rate tax relief due to public concern that high earners are receiving substantial rewards and benefits.
“However as the Chancellor has applied this measure only to higher earners it seems to amount to an implicit endorsement that salary or bonus sacrifice remains effective for the vast majority of employees who earn under £150,000,” he said.
Martin Palmer, head of corporate pensions marketing at Friends Provident, said any ‘attack’ on pension tax relief could send the wrong message to both scheme members and employers: “This could be a dangerous trend if the government does nothing to re-rate the earnings level each year. The administration of this tapering away of tax relief will increase complexity and the cost of running pension schemes for limited benefit to the Exchequer.”
The Chancellor of the Exchequer, Alistair Darling, announced in today’s Budget that tax relief on pension contributions is to be restricted for those with incomes above £150,000 pa from 6 April 2011.
The restriction on tax relief will apply not only to an individual’s own pension contributions but also to any contributions made on their behalf by their employer or any other party. This means that employer contributions paid in respect of high earners will no longer be tax-exempt as far as the employee is concerned.
the HamishWilson Team
Patrick King, Tax Principal at MacIntyre Hudson, comments:
“Given the Chancellor’s decision to restrict tax relief on pension contributions to the basic rate for high earners from 2011, it is understandable that he would want to introduce a transitional measure to prevent people making extra contributions over the next two years before the restriction in tax relief comes into effect. However the anti-forestalling provisions he has announced today go much further than that.
“In the detail of the Budget announcements, it is proposed that a new allowance and tax charge will be introduced from today. The tax charge, which has the effect of withdrawing higher rate relief, will apply to anyone who earns more than £150,000 in the current year, or who has done so in either of the two previous tax years. It will therefore catch many more people, some earning well under £150,000 this year, particularly entrepreneurs whose earnings tend to fluctuate from year to year.
“Pension contributions of up to £20,000 per annum are protected, as are contributions above that level which are normal, regular ongoing contributions. However, normal, regular ongoing contributions are defined as those made under previous arrangements that have been paid quarterly or more frequently.
“Therefore anyone earning over £150,000 in any of the last three years, and who normally makes contributions of over £20,000 per annum, but makes their contributions less frequently than once a quarter, will be caught by the anti-forestalling provisions.
“For many entrepreneurs and owner managers, prudence requires them to defer making contributions until they know they can afford it. Many therefore make small regular contributions to their pensions, and then make larger occasional contributions as their finances allow. Under these proposals, entrepreneurs taking this sensible approach, face losing some or all of their higher rate tax relief on their pension contributions from today, even though they are contributing no more than they have in previous years.”
MacIntyre Hudson points out that the proposals also contain an anomaly between their treatment of money purchase and final salary schemes.
Patrick King explains:
“Under the proposals, for people in defined benefit schemes, the normal regular ongoing savings that are protected include any increase in pension benefits under existing scheme rules, including any increased benefits due as a result of normal pay rises and progression. So while those in final salary schemes have their higher rate tax relief on increased contributions based on an increase in salary protected, those in money purchase schemes do not.
“This creates serious distortions between the wealthy self-employed and the company executive. An entrepreneur who sees his salary rise by only £5,000 above the £150,000 limit and contributes more than £20,000 a year to his pension will be subject to the charge. Meanwhile, a senior executive on a defined benefit scheme – that factors in career progression – and sees his salary rise by £50,000 to £195,000 will get away without paying a penny. ”
Chris Noon, Partner at Hymans Robertson, responds to the changes in tax relief on pension contributions announced in the Chancellor’s budget:
“The proposed changes in the Budget to tax relief on pension contributions by the highest earners bear the hallmarks of a politically expedient quick fix to the Government’s fiscal problems. The move represents little more than short-term tinkering in an area where long-term clarity and stability should be the goal.
“There may well be a case for the richest to bear the larger share of the burden of financial adjustment but, as recognised elsewhere in the Budget, there are simpler and more direct ways of achieving this end. There is certainly a case for tax relief to be restricted to the basic rate: most higher-rate taxpayers become basic rate taxpayers when they retire. But, on that basis, tax relief should be restricted for everyone and any changes should be made only after consideration of consistent changes to the taxation of pensions in payment.
“Under the current proposals, it appears that pension saving for higher earners could become an inefficient retirement savings vehicle as these employees are most likely to be higher rate tax payers in retirement. The real danger is that once pensions become less interesting for senior managers, they may show less interest in them as a savings vehicle for employees.
“The income tax changes for employees earning more than £100k potentially introduces an opportunity for tax arbitrage. It may be possible for individuals to defer additional pension contributions this year and pay more next year at a higher rate of relief.”
Xafinity Consulting’s Pat Wynne commented:
“Higher income earners will look for alternatives to by-pass today’s announcement to restrict tax relief by reshaping their overall remuneration package. I predict that the likely outcome of the Chancellor’s plans will be an increase in work-place pension provision by salary sacrifice. This may circumvent the tax relief change – depending on the legislative detail. Using salary sacrifice would also result in a reduction in the amount of National Insurance contributions (a tax by any other name) paid by affected employers and employees.”
Pat continued …
“The cutting of tax relief in itself is a negative message. Indeed, the announcement could be seen by the general public as a first step in abolishing pension tax relief entirely, or more simply as yet another anti-pensions message, at a time when Government should be encouraging long-term saving. It is also the final nail in the coffin of the concept of pension tax simplification!”
Tom McPhail, Head of Pensions Research ‘By breaking the link between income tax and pension tax relief, the government is setting a dangerous precedent for the future. The government is undermining important incentives to defer consumption; it has also presented us with yet more complicated pension administration rules.
The government seems to assume that anyone who earns over £150,000 can be lumped into the same boat as Sir Fred Goodwin, but that doesn’t make it alright to deliberately undermine their pension provision.’
Danny Vassiliades, Principal at consulting actuary Punter Southall, comments on the Budget
“Punter Southall notes the huge public sector borrowing requirement. This is clearly of concern for the long term economy as a whole and is likely to lead to a rise in long term interest rates. Perversely one of the unintended consequences might be that rising interest rates will facilitate a reduction in the assessment of pension scheme liabilities and bring the prospect of settling liabilities a little closer.
“We are relieved that the much mooted changes to higher rate tax relief for pension contributions will affect fewer people than expected judging by the principles set out in the interim measures which have been introduced pending consultation on the actual rules. However for the first time the Government appears to be setting a norm level of contributions of £20,000, which disappointingly reduces the welcome flexibility introduced by their own pensions simplification introduced by the Finance Act 2004.
“With regard to the wider changes to introduce a 50% tax rate for earning in excess of £150,000 there is a risk that this will affect a much wider range of people than that implied by the Government’s top 1% designation. The greatest impact is likely to be on the lone breadwinner family rather than on the “super” wealthy who are likely to be able to continue to manage their affairs to mitigate the impact and could move to more advantageous tax jurisdictions.”
Mercer has welcomed the government’s decision to consult on the removal of higher rate tax relief from pension contributions. Removing tax relief for a small group of employees is not as easy as it seems and could have structural consequences that undermine existing defined benefit provision.
According to Dr. Deborah Cooper, head of Mercer’s retirement resource group, “Pension saving is lightly taxed relative to most other forms of saving. This is presented by the government as an incentive to encourage people to make provision for their retirement. This policy must continue. Poor investment returns, an aging workforce and increasing longevity is putting the UK’s pension structure under increasing stress. Maintaining the current system of tax relief on contributions, which allows people to defer paying tax until retirement rather than avoiding it completely, would be a welcome break from other recent policy changes that have led to the closure of many defined benefit schemes. It is vital that all political parties look at this issue over the long term and continue to support and develop incentives to save for old age rather than remove existing ones.”
The government estimates that individuals, including both employees and self employed, contributed £25.7 billion to pension schemes in 2007. Mercer estimates that as many as one fifth of people saving into pension schemes are higher rate tax payers. This group has often been accused of getting an unfair advantage from the tax relief available on their pension savings.
However, according to the consultancy, the issue isn’t clear cut. For example, tax saved when contributions to a retirement fund are made isn’t entirely avoided. It has to be paid when the employee retires and receives those contributions in the form of income. Deferring tax smoothes out inequalities in the tax system by spreading the measurement of an individual’s tax liability over a longer period than one year.
“It is a case of tax deferral, not tax relief,” commented Dr Cooper. “Because income tax is measured on a yearly basis, it creates inequalities between people with different earning patterns. An employee whose pay is sometimes below and sometimes above the higher rate threshold will pay higher tax than an employee whose pay is constant and just below the threshold – even though on average they receive exactly the same pay,” she argued. “If higher rate tax relief on pension contributions is removed, then anyone whose pay takes them above the higher rate threshold, but retires with a pension below it, will have been taxed at higher than a ‘fair’ rate.”
Mercer believes that the majority of higher rate tax payers are likely to be basic rate tax payers in retirement. The company believes that removing higher rate tax relief from their pension contributions effectively pushes them into a higher tax bracket than they would have been in otherwise. So the concept of fairness promoted by those supporting the removal of higher rate tax relief is not robust.
Mercer estimates that, based on the amount of money individuals contribute to the various forms of tax exempt pension scheme and assuming that the withdrawal of tax relief didn’t change any behaviour, removing higher rate tax relief from individual contributions would result in an extra £1 billion for the Treasury. This, believes Mercer, is also a flawed argument.
“Behaviours will change,” said Dr Cooper. “Pensions will become less attractive relative to, say an ISA. Employers will rearrange their scheme design so that employees are not expected to contribute. If all private sector employers decided to make their pension schemes non-contributory, the tax relief saved would fall by about £500 million. The governments would suffer knock on reductions in National Insurance receipts. The groups left having to pay extra tax would be public sector workers – unless public sector employers, including the government, also changed their benefit designs to become non-contributory – and the self employed.”
Clive Grimley, Partner at Barnett Waddingham, commenting on the Chancellor’s Budget speech today, announcing a restriction of higher rate tax relief on pension contributions of people earning over £150,000 p.a. says:
“This is Gordon Brown’s second tax raid on pensions, the last being the removal of advance corporation tax relief; today’s change seems to be entirely contrary to the tax simplification of pensions, which was only introduced with effect from April 2006.
It will not affect new contracts of employment for higher earners, but it will apply higher taxes and limit tax relief on pension contributions of current highly paid employees; it will prevent those employees gaining the tax advantages offered by sacrificing salary or bonus in favour of a higher employer paid pension contribution. Politically this may be a good time to restrict higher rate tax relief due to public concern that high earners are receiving substantial rewards and benefits.
However as the Chancellor has applied this measure only to higher earners it seems to amount to an implicit endorsement that salary or bonus sacrifice remains effective for the vast majority of employees who earn under £150,000.”
Martin Palmer, Head of Corporate Pensions Marketing at Friends Provident said:
“Wording in the budget report suggests an urgent need of clarity for what the £150,000 and over figure refers to. Does the restriction on pensions contributions for those with incomes of £150,000 purely mean earnings or does it also include other incomes such as from savings or investments”.