Get prepared: Pension tax reliefs maybe changing
The prime minister has suggested the 40 per cent tax relief offered to higher rate earners on their pension contributions will be cut at the next Budget, as a way to ''level up' the opportunity across Britain.
There is no doubt that the pension tax relief is hugely expensive for the government but attempts in the past to reform the pension system have met resistance, particularly from Tory MPs. Things could be different this time. With Sunak, our new chancellor, announcing that he plans to keep the existing 11 March Budget date, the Tory government are telling the public that they are looking to make the tax system 'fair and efficient' and indeed in their election manifesto vowed to 'remove arbitrary tax advantages for the wealthiest in society'.
This may seem a little at odds coming from a Tory government but with public finances under strain, we know tax changes are coming and we cannot disregard the real threat of a loss of the pension tax relief. Sunak needs to find funds to improve public services, most notably the NHS and social care for a growing ageing population, and with little money currently at his disposal. So what will the removal of the tax pension relief mean in real terms?
The current pension tax system - an example in today's terms:
There is a Lifetime Allowance limit on pensions of £1.055 million of money you can take out tax efficiently. Anything above this amount you are taxed extortionately.
In order to achieve this level of income, you need to save around £12,000 a year for about 40 years.
If you manage to save enough as you reach retirement age of 65, based on current annuities of about 5%, you will earn around £50,000 per year.
You will likely take advantage of the hugely beneficial tax free lump sum on retirement, which is set at 25% of your pension pot. In our example, therefore, you will have £37, 500 remaining each year.
If you add on the full State Pension of £9,000, you are just below the higher rate tax band
This means that under current rules, you can move your money from a 40% tax rate to a 20% tax rate. with perhaps a little of your personal allowance left too after your state pension is taken into consideration
Your pension can be passed on to you beneficiaries or children outside of your estate, so it does not get caught by Inheritance tax (IHT).
So if the chancellor, Sunak, does decide to remove the pension tax relief incentive, what is the benefit of saving into a pension?
If the 25% tax free lump sum is still available, then that may be enough. We also can't disregard the benefit of getting free employers contribution. Then of course, the IHT implications.But then the question arises, can you trust that these benefits will still be available to you when you retire, in particular the 25% tax free incentive?
If you look at the number of times the Lifetime Allowance has changed since 2006 - four times - you could be wondering, if you are 20 or 30 something, will it really be worth me saving into a pension? A good alternative could be to save into your ISA each year utilising the full £20,000 tax free income and where it is more easily accessible and less likely to be subject to the whims of government policy.
Watch this space .
