To tax or not to tax? That is the question

Spence & Partners latest blog for Pension Funds Online - Chancellor George Osbourne announced his Summer Budget on 8 July with a number of key developments for the pensions industry. The main one being that the annual allowance will be reduced from April 2016 for individuals with income, including their own and their employer's pension contributions of more than GBP 150,000. The Chancellor also launched a consultation requesting industry views on reforming pensions tax relief. Annual Allowance Firstly let's discuss the Annual Allowance. It will be reduced by GBP 1 for every GBP 2 of income above GBP 150,000 up to a maximum reduction of GBP 30,000. For someone with income of GBP 210,000 or above, the Annual Allowance will therefore reduce to GBP 10,000 – meaning that approximately only 5% of income will attract pension's tax relief. This reduction in the Annual Allowance for high earners raises the question of alternative savings vehicles becoming even more attractive – with limited tax relief on contributions, is pension saving the best course of action for high earners? Are workplace ISA's the future? The reduction will apply from April 2016 but until then, to ensure maximum tax relief, higher earners should make use of the transitional rules being put in place and ensure that the full Annual Allowance and any carry forward from 2012/13, 2013/14 and 2014/15 have been exhausted. However, in doing so, care must be taken not to breach the new reduced lifetime allowance. Tax Relief Secondly, if tax relief is scrapped altogether, this could mean another radical change in pensions practice not long after the 6 April pension freedoms were introduced. Under the current taxation system, pension contributions receive tax relief and benefits are taxed in payment. If tax relief is abolished, then pension contributions will be taxed and benefits will be tax free. The consultation, which ends on 30 September 2015, does not put forward any proposals it is merely a call for views and it is therefore difficult to comment on the likely outcome; however I have noted some initial thoughts below: - Administering pension schemes would certainly become simpler however this may be to the detriment of retirement saving in general as the incentive of tax relief on contributions is removed; - This again raises the question of pension schemes being the most appropriate savings vehicle going forward; - Thought would have to be given on where to 'draw the line' i.e. when does taxing of benefits stop? This will have to be communicated well in advance to ensure people are targeting the correct level of benefit in retirement and to ensure no one gets a 'free ride' (i.e. tax relief on contributions and tax free benefits); - If tax relief is abolished for employees, salary sacrifice schemes become much more attractive and we are likely to see a rise in the number of employers implementing such arrangements. However it should be noted that the government are actively monitoring the growth of salary sacrifice arrangement and the effect on the tax receipts. Tax relief on income tax and national insurance contributions cost the government almost GBP 50 billion in 2013/14. Scrapping tax relief would see an immediate increase in revenue, with a reduction in future years as people reach retirement. Are tax revenues better utilised now or in the future? This is the ultimate question. Pension Funds Online