Last week it was reported that chancellor George Osborne had drawn up plans to overhaul pension tax relief, cutting relief for higher rate taxpayers by introducing a flat rate.
In the 2013/14 tax year, the gross cost of registered pension scheme tax relief was £35 billion, with £10 billion spent on national insurance relief. With a 2015/16 national budget deficit of £69.5 billion, it is no surprise the chancellor is looking to save money.
The annual allowance is currently £40,000 but the government is planning to taper this down to £10,000 from April this year for anyone earning over £150,000 a year. The taper has been criticised for adding yet another level of complexity so would a flat rate allow Osborne to drop this unpopular policy? If he went with a flat rate of 20% for everyone and kept the annual allowance at £40,000 it would save around £12.6 billion. He would save a lot more if he reduced the annual allowance down to £20,000.
Employers facilitate tax relief on pensions using two different systems. The “so called” net pay method deducts pension contributions from employee’s gross pay. These schemes may need a year to transfer to the flat rate, but they pose a problem because they do not have a mechanism for those earning below the income tax threshold of £10,600 to claim tax relief on contributions. Instead, pension tax relief could be applied only using the second relief at source arrangement, whereby investors make contributions net of tax relief and pension providers then claim top-ups from the government.
A 40% taxpayer making a £40,000 pension contribution would lose out on £4,000 under a 33% flat rate, rising to £6,000 in reliefs under a 25% flat rate. A flat rate of 25% would benefit lower earners paying a lower rate of income tax as it would effectively top up their pension contributions. This system will also benefit the vast number of small businesses rolling out auto enrolment this year as it will be easy for them to administer and for their employees to understand.
With this potential deadline looming it is essential that you seek guidance and advice so please do not hesitate to get in contact.