As Rishi Sunak, the new chancellor, prepares for his first Budget next week, the pensions industry will be watching what happens with eagle eyes.
Reports have circulated that the government, emboldened by its landslide General Election win last year, could bring in sweeping changes to how some people save for retirement. Some predict that Sunak will take aim at the complex and contentious pension tax relief. Others hope he will make the system more friendly to those who have invested well.
With a wish list ranging from specific measures to make it more profitable for doctors to stay in work, to broad-brush reforms which could turn the industry on its head for low earners, Barnett Waddingham’s pensions specialist James Jones-Tinsley tells City A.M. how the chancellor can bring about meaningful change in the sector.
How can the chancellor help people understand pension tax relief?
First, simplify it. Currently, personal contributions to a pension attract tax relief at the highest rate of income tax paid by an individual. However, the way tax relief works is opaque and largely misunderstood. If the chancellor agrees to introduce the same rate of relief for everyone, regardless of earnings, the chosen rate should be at a level that encourages basic rate taxpayers to save into a pension, while not over-penalising higher rate taxpayers.
For these reasons, a flat rate of 20 per cent is too low. A rate of 30 per cent or above would be more reasonable.
Such a seismic change should not be rushed, however. Instead, the chancellor should set up an independent commission to agree the rate and oversee its successful delivery, in much the same way as happened with auto-enrolment.
What changes would help older workers keep high pension contributions?
Ditch the money purchase annual allowance. Where a saver aged 55 or over starts to take income from a money purchase pension scheme, the amount that they can carry on paying into their pension shrinks from £40,000 a year to just £4,000.
This is a largely unknown tax trap that is too easily triggered, and unfairly prevents older workers from making significant pension contributions when they may need to.
How to prevent good investment performance from being taxed?
Scrap the lifetime allowance. This is the maximum amount that a person can save into pensions during their lifetime. 10 years ago, it stood at £1.8m. Today, it is £1.06m — nearly £750,000 lower. Its austerity-led reduction over the last 10 years has effectively turned it into a tax on successful investment performance, with any excess taxed by as much as 55 per cent. Today’s low annual allowance has all but made the lifetime allowance redundant.
How can the chancellor help high earners like doctors?
Get rid of the tapered annual allowance. This reduces how much someone can pay into their pension when their annual income is more than £150,000. The rules surrounding it are far too complex. As a result, many people, including doctors and other public sector professionals, end up facing significant and unexpected tax bills where they inadvertently contribute too much to their pension. Any tax rule that makes doctors refuse to work extra shifts in order to reduce patient waiting times — as we have seen — has to be ditched.
Finally, what is the most important issue for lower income workers?
End the tax relief inequality in workplace pension schemes. Lower earners have typically been auto-enrolled into workplace pension schemes since 2012. Some of these schemes operate on a net pay basis, while others offer relief at the source.
This means that employees who earn less than the personal allowance of £12,500 and are auto-enrolled into a net pay scheme do not receive pension tax relief on their contributions. Those auto-enrolled into a relief at source scheme do.
To borrow from the chancellor’s own words, the tax treatment between the two types of scheme needs to be “levelled up”, so that lower earners are treated the same from a tax relief perspective, regardless of which type of scheme they join.