Stephen Green, a senior consultant at Towers Watson, said:
“In 2010, the Government said that a £50,000 annual allowance would give people ‘greater flexibility’ over when they do their pension saving and would ‘impact on fewer individuals on lower incomes’ than the lower allowance figures it had been contemplating. It’s equally obvious that a lower annual allowance will now catch more people on five- rather than six-figure salaries in final salary schemes, including public sector employees whose accrued pensions remain linked to final salary, and will make it harder for members to catch up on pension saving later in life when they have the money to spare.
“The Chancellor’s comment in March that he would not be restricting tax relief ‘in this Budget’ turned out to be ominous. It’s understandable that the Treasury wants to keep its options open but pension planning would be easier if there was a firm signal that a third bite will not be taken out of this particular cherry.”
What £1.25 million lifetime allowance means for maximum pensions
Stephen Green said: “A £1.25 million lifetime allowance is equivalent to a defined benefit pension of £62,500 a year. Under the pre-2006 ‘earnings cap’ tax regime, people could accrue pensions of up to nearly £97,000, so this tax threshold has effectively now been reduced by about one third.
“At current annuity rates, a defined contribution pension pot of £1.25 million would buy a 65 year old a pension of about £47,000 with 3% increases and a 50% spouse’s pension.”
“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.”
“It is welcome that the Government are proposing allowing members the chance to protect a lifetime allowance of £1.5m but the need to opt out of future pension saving to do so will be a very difficult decision for members to make. Unlike the changes at A-day, these decisions will not be confined to a company’s most senior executives. Employers and pension schemes will need to carefully consider what guidance and support they can provide to help a large number of members with these decisions.
Bringing tax forward, not just increasing it
Stephen Green said: “The Government says cutting the annual and lifetime allowances will raise £1 billion a year by 2015/16 but some of this is funny money: if less money goes into pensions now, less will come out and be subject to tax further down the line. The overall long-term boost to the public finances from cutting pension tax relief is smaller than with other £1 billion tax rises.”
Different treatment for public and private sector employees
Stephen Green said: “There is a trade-off between fairness and keeping the calculation simple when valuing defined benefit pensions for annual allowance purposes. For example, the taxman pretends that a £30,000-a-year defined benefit pension is worth the same regardless of whether it starts being paid out at 60 or 65. Older public sector employees who have kept a pension age of 60 will therefore be more favourably treated than defined benefit members in the private sector. With annuity rates where they are now, the lifetime allowance is also more favourable to the mostly defined benefit public sector than it is to the predominantly defined contribution private sector.”
What about indexation?
Stephen Green said: “When the Government set the annual allowance at £50,000, it announced that it would not be indexed until 2016 at the earliest. Today, it has published public finance projections stretching further into the future. If these do not assume indexation, the limits will continue to fall in real terms. Members of pension schemes must know whether the limits will be indexed in order to plan their future savings appropriately.”
Administrative issues
Stephen Green said: “If cuts to pension allowances have to happen, waiting until 2014/15 is sensible. Because pension input periods are not always aligned with tax years, this is the only way to avoid a situation in which money already saved takes people above the limit were it to decrease in 2013/14. Some people affected by the lifetime allowance cut also face complicated decisions so it’s good that they have been given 15 months to make them and seek the advice they will undoubtedly need in order to make an informed decision.
“Some people will curtail pension saving rather than go through the complicated process of calculating and paying an annual allowance charge but that is most likely to happen where employers are prepared to adjust reward packages and offer cash alternatives to pensions. Where these are not available, which might especially be the case in the public sector, paying the tax charge can be better than coming out of the scheme. Pension schemes can sometimes be forced to act as tax collectors when members face tax charges in excess of £2,000 and would prefer that the tax bill was met by reducing their benefits than by writing a cheque.
“20 months after the annual allowance was set at a level that starts to affect people, wrinkles in the legislation are still being ironed out, for example how benefits being paid out can be reduced to meet annual allowance charges. The greater the number of people who might be affected, the greater the administrative challenge.”
|
