The next stage of the pensions revolution has been cancelled, it seems, or at least postponed.
After his sweeping pension freedoms, introduced last year, Chancellor George Osborne had been expected to order even more radical changes in the Budget on March 16.
But with the Brexit vote in June and a possible Conservative party leadership battle ahead, Mr Osborne has backed away from moving to a controversial system of “pension-Isas” that would have incensed many MPs.This does not mean there won’t be some sort of pensions tax raid.
The most likely options are a cut in the amount you can save each year. This annual allowance, currently £40,000 for all but the highest earners, could be cut. The amounts suggested by pundits vary from £10,000 to £25,000.
Perhaps more likely would be a tinkering with the tapering on the annual allowance that sees it steadily reduced to £10,000 for those earning between £150,000 and £210,000. Here, the experts suggest the threshold for those affected could fall to £125,000 or even £100,000.
Finally, there could be a further reduction on the lifetime allowance. All of this is explained below.
The next pensions revolution: the background
In the summer Budget last July, he said a consultation would be undertaken on whether wholesale changes to the pension system were needed, citing concerns about the fairness of handing out billions in tax relief largely to better-off savers.
For instance, the annual limit on pension saving, which is £40,000 for most, could be reduced. It could fall as far as £10,000. The lifetime allowance, once as high as £1.8m, will be cut from £1.25m to £1m from April. According to some news reports, the Treasury has consulted on a £750,000 limit.
The proposals for pension change
While the chancellor appears to have backed away from these options for now, they could just be delayed. Another process of consultation could be announced.
The most radical proposal was a move to so-called pension-Isas. Today’s pensions, which are untaxed on the way in but taxed on the way out (apart from a 25pc tax-free lump sum), would be kept but closed to new money. A new system would be set up more in the spirit of Isas, where contributions receive no tax breaks but the money will eventually be withdrawn tax free. The appeal to the Treasury is a huge saving on the tax-relief bill today, with the cost handed to governments of the future.
The main reason not to do this would be the complication that would follow. A two-pots pension system would create headaches for companies to operate and for individuals to understand and plan their finances around. The other reason would be the blow to confidence in retirement savings, a point made by former pensions minister Steve Webb
Keep the existing structure but remove the tax relief that is so beneficial to higher-rate taxpayers. It is expected that a flat rate of relief might replace the current rates – so that basic-rate taxpayers would receive more and higher-rate taxpayers would have less.
Pension would money would still be taxed on withdrawals, apart from the 25pc tax-free lump sum element.
The savings industry has lobbied the Treasury that if a flat rate is necessary, it should be 33pc. This could then be marketed to savers as “buy two get one free” because every £2 invested would be topped up by £1. However, it would save little money for the Treasury.
The Treasury might go with the flat rate system but instead opt for a 25pc rate that would offer substantial savings to the public purse.
With both options two and three, critics point out that tax relief on higher rates may be costly but the principle is fair. Without it, savers would effectively be taxed twice on their pension money: when they invest and when they withdraw.
The hybrid option is to take some of the above. Namely, a move to a pensions-Isa system but where basic rate tax relief is retained, or what has been called a 20pc ‘bonus’. This was mooted as a proposal but faced a backlash, forcing a rethink.
The lifetime allowance, the total each person can hold in a pension without facing penalties, was once £1.8m but it will fall to £1m in April. A further cut could be announced. Treasury officials have been reported as considering an eventual £750,000 limit. This would provide a guaranteed income of just £19,450 a year, based on a man aged 65 taking 25pc tax-free and buying an index-linked annuity with the rest. The Government may deem this to be a livable amount for most pensioners, when put together with the state pension.
The annual allowance on pension contributions may also be changed, especially now the wider proposals appear to have been dropped. This limit, once as high as £255,000, was reduced from £50,000 to £40,000 in 2014. Experts have suggested a cut to £25,000, although it could be deeper now that changes to the rates of relief have been all but ruled out.
The tapering on the annual allowance could also be altered.
Increasing the personal allowance, the amount you can earn before income tax kicks in, has been a favourite Budget sweetener for Mr Osborne for many years. From £10,600 this year, it will rise to £11,000 next year and £11,200 in 2017/18. The higher rate threshold will be £43,000 next year, then £43,600.