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Pensions Tax Privileges under attack

Danby Bloch, 05 Jun 2014


Various think tanks and politicians have decided that it’s time to attack the tax privileges enjoyed by registered pensions. The Centre for Policy Studies reckons that the total cost over the last decade is at least £360 billion. Advisers need to decide how to deal with the problems this raises in their advice to clients, steering a fine line between the responsible – raising awareness – and the inappropriate – scaremongering.

Arguably the most credible attack on pensions came earlier this year from the Institute for Fiscal Studies (IFS). This highly respected think-tank described the tax regime for employer pension contributions as “extraordinarily generous” and called on the government to make these inputs subject to employer NICs.

Pension contributions by employees and self-employed people don’t benefit from this particular relief. But employer contributions go straight to the pension provider and so escape the 13.8% NIC liability, which is a tax in all but name. They also escape employee NICs, which are 12% or 2% depending on the employee’s level of income.

The IFS also argued that the government ought to restrict people’s ability to withdraw tax-free lump sums from larger pension pots. The PCLS has been an on-off target for politicians on all sides as well as for other commentators. Back in the 80s, the Tory chancellor Nigel Lawson attacked it as “anomalous but much loved”, but political pressure stopped him abolishing it. However, the IFS argued against any further restrictions on income tax relief on pension contributions.

In contrast, the generally rightwing think-tank Centre for Policy Studies (CPS), has recently argued that tax relief on pension contributions should be scrapped altogether. In its view, the relief primarily benefits higher-rate taxpayers and does little to inspire low earners to save for retirement.

The CPS also favours the retention of NIC relief on employer contributions as a means of encouraging employer engagement with pensions, but wants to abolish the 25% tax-free lump sum. The Centre proposes various compensations for the removal of tax relief. They include a single flat rate tax relief of 25% or 30% to incentivise low earners to save and a combined contributions limit of £30,000 – £40,000 for pensions and ISAs.

Then just before the CPS report was published, the Lib Dem Pensions Minister, Steve Webb, argued strongly for flat rate 30% relief for all. Under a Labour government, higher rate tax relief would be under threat and the lifetime allowance might be reduced further.

Advising through uncertainty
Faced with these high profile suggestions and an election in May 2015, what should advisers recommend to clients about their pensions?

Back to raising awareness. First of all advisers should stress that they are not in the political forecasting business, especially in a year so very full of uncertainty as this one will be. The possible permutations of party alliances could throw up a variety of outcomes, with unpredictable results for pensions. But they also need to explain that governments of all political shades will be under pressure to raise cash and that the tax relief on pensions is expensive and is perceived as mainly favouring the relatively rich. The coalition government has cut back on pension tax privileges and more leftward leaning governments might well go further.

But there is another general point that suggests a very measured approach. Successive governments have generally not legislated retroactively on pensions. Even where they did, as in the 2006 so-called “simplification” revolution, protection was introduced for people with large pension pots who would otherwise have been caught by the lifetime allowance.

The tax-free PCLS seems to be under a variety of possible threats. So it could be argued that clients should take the PCLS as soon as possible, before it is abolished or further limited in some way. The trouble is that this approach could turn out to be expensive for clients who would otherwise benefit greatly from the flexibility to take tax-free amounts each year and bring down their tax rates substantially under the new drawdown regime. This kind of new-style phased retirement would be closed to them if they decided in a panic to take all their PCLS now.

The other area for advisers to think about is the possible change to tax relief on contributions. That might mean more tax relief for basic rate payers and would almost certainly mean less tax relief for 40% and 45% taxpayers.

It could be pretty irresponsible to suggest to a 20% taxpayer that they should postpone making pension contributions because more tax relief might be in the offing in a year or so’s time. The uplift might not turn out to be very significant and missing out on several years’ fund growth would be a mistake. Any client who took this line would need to make sure they kept saving for their retirement in other ways – perhaps through the new ISA.

But it might make sense for higher or additional rate taxpaying clients to invest as much as they can in pensions in the next year or two – assuming it fits into their financial priorities generally.

This artice appears in Money Marketing 12 June 2014


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Danby Bloch

Editorial Director, Taxbriefs

Danby Bloch is the editorial director of Taxbriefs, chairman of city-based IFAs, Helm Godfrey and director of Nucleus, an independent wrap provider.

Over a period of more than 40 years, Danby has established himself as one of the industry's leading thinkers and  is a respected author, lecturer and trainer on tax and financial planning.




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