There are rumours, reliable ones, that on 16 March 2016, when Chancellor George Osborne lays out his budget and reports on the outcome of the pension tax-relief review, he will also announce that he is going to axe the generous tax relief on pensions, an axe that could come down hard with immediate effect. How will the potentially major changes to pension tax relief affect investors? The Financial Times among other reputable sources is suggesting the chancellor is planning to announce a flat-rate "savings incentive" of between 25% and 33% for everyone. While Treasury insiders waive away curious journalists and commentators saying, "No decision has been made yet", sources close to Number 11 predict that a reduction in tax relief for higher earners is "almost certain".
Tax relief on pensions as it stands now
The most attractive aspect of pension saving is the boost given to contributions in the form of tax relief. At present, every £100 a basic-rate taxpayer contributes to a pension attracts a government boost of £25. For every £100 a higher-rate taxpayer contributes, government adds £25, but then the higher-rate taxpayer can also claim another £25 relief via the self-assessment tax return. The total benefit for higher-rate taxpayers therefore is HUGE: £50 for a net £75 contribution ? a 67% uplift.
Possible impact on tax relief on pensions from 16 March 2016
The dread among higher earners is that instead of how it stands now, their relief will be limited to 25%, 33%, or even 20% basic-rate tax.
Is everyone a loser?
Higher-rate taxpayersThe 4.5?million middle and higher earners, paying 40% tax on the top part of their income, will probably lose tax relief at the 40% rate. This might mean losing a benefit worth up to £8,000 a year. These taxpayers could consider bringing forward any planned pension contributions before March 2016, just in case.
Basic rate and zero-rate taxpayersThese taxpayers could consider holding off on any planned contributions for a few weeks, just in case any changes take effect immediately, and the tax relief goes up by a percentage or two.
Age-related considerationsAnother thing to think about is age: higher-rate taxpayers who are close to being able to access their pension (age 55), could make pension contributions now to get the higher rates of tax relief. Additional rate taxpayers, remember, should take notice of the new limits announced at the pre-election budget 2015.
Additional-rate taxpayersTaxpayers who attract the additional or highest rate income tax at 45% will probably have taken on board the announcement at the last budget that, from 6 April 2016, the new "lifetime allowance" will decrease from £1.25m to £1m. Upper-income bracket taxpayers should be very careful when making further contributions if there is a risk of breaching the allowance threshold or they could be punched hard by a tax bill.
So what is the more likely outcome of a more-than-likely announcement?
If, as several analysts have suggested, the Chancellor’s main objective is to save money, it seems probable that higher earners will see their tax breaks cut even more. The general feeling is that if the Chancellor does announce the loss of the 40% relief on pensions on Budget day, the cut-off for claiming it would be instantaneous. Could this "surprise" tactic be to prevent those who can from making large investments to pension savings? If Osborne was to announce a run-up period of, say, a year that would blow a hole in the Exchequer’s forecast based on savings from pension tax relief.
What could taxpayers do?
If possible, 40% taxpayers, and any taxpayers well clear of the threshold for contributions, might make maximum pension contributions within the next few weeks to benefit from current levels of tax relief. For other groups the decision is less clear-cut: they may be better off holding back from pension contributions until the Chancellor makes his speech, as pension tax relief could go up by a percent or two.