Martin Lewis issues warning over pension tax
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HMRC released pension statistics on September 30 which highlighted savers are contributing billions to their private pensions. Jon Greer, the head of retirement policy at Quilter, welcomed this news but warned the gains are being diminished by rising tax costs.
A highly complex tax system
Mr Greer said: “The good news is that new figures from HMRC show that savers were ploughing more money into their personal pensions than ever before prior to the pandemic. However, what these figures will look like post pandemic is yet to be seen.
“While many people have managed to save additional funds during lockdown, others have not been so fortunate and will be faced with the choice of having money today to make ends meet or saving for retirement. It is likely and understandable that they may choose the former and the picture will be less rosy.”
According to HMRC, £31.3billion was paid into personal pensions in 2019 to 2020, up from £27.9 billion in 2018 to 2019. The total value of contributions to personal pensions rose over the last three years by an average of 11 percent per year.
Contributing to private pensions is considered essential by a range of financial experts, who warn savers may be in for tough retirement years if they fail to act. However, examining the data further, Mr Greer warned complicated tax and allowance rules are diminishing these good intentions.
“The bad news is that the figures also show that our highly complex tax system is catching an increasing number of people out as annual allowance and lifetime allowance charges begin to spiral,” he continued.
“Annual allowance charges, which have been plaguing the NHS causing doctors to reduce their hours is up around 15 percent in 2019/20 compared to the previous year. Similarly, the total value of Lifetime Allowance charges reported by schemes in 2019 to 2020 increased 21 percent to £342million.
“It is worth bearing in mind that the Lifetime Allowance tax charge was originally only supposed to impact 5,000 individuals yet is now penalising far more than that each year.
“The Government should be doing everything it can at present to encourage savers to put money away for their retirement.
“While auto-enrolment has been a very successful step in the right direction, it’s important that the highly complex rules around the annual allowance don’t hamper the good work the policy has done. These rules require an intricate knowledge of the UK’s pension landscape to understand and therefore time and time again catch people out.”
The same data from HMRC showed pension tax relief rules are “costing” the Government, and by extension taxpayers, billions. With an Autumn Budget looming, some have warned Rishi Sunak may be tempted to alter the tax relief rules to save money but the Chancellor has been urged to go against this.
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Pension tax relief
The statistics from HMRC showed the cost of providing pension tax relief increased by over £4billion between 2017 and 2020, reaching just over £41billion in total. Mr Sunak is expected to examine his options for cutting costs ahead of the next Budget but Steve Webb, a partner at LCP and former pensions Minister, warned the increase in pension tax costs “is not an excuse for the Chancellor to raid pensions in the Budget.”
LCP argued the rise in the cost of tax relief reflects millions of “ordinary savers saving more, and should be celebrated rather than used as an excuse for cutting back.”
Analysis from LCP detailed the growth in the cost of pension tax relief is “affected by a range of factors, notably the increase in statutory minimum pension contributions under automatic enrolment from two percent in 2017/18 to eight percent in 2019/20 which will have led to a growth in the cost of the relief. More than half of all workers brought in to pension saving as a result of automatic enrolment are estimated to have contributions made at the statutory minimum level, which means that the cost of tax relief on contributions rises significantly when minimum statutory contribution levels rise.”
Pensions experts at LCP noted, despite the headline £41.3billion quoted cost of pension tax relief, this is “not simply a pot of money into which a cash-strapped Chancellor can easily dip.”
Based on recent work carried out by the Pensions and Lifetime Savings Association on statistics for an earlier year, LCP estimated:
- Around £1 in £7 of the tax relief bill relates to a typical £10-£15billion per year being paid by companies to clear deficits in their Defined Benefit (DB) pension schemes; applying tax in some way on these contributions would simply penalise companies who are being pressed by government and regulators to tackle shortfalls in their pension schemes;
- Around £1 in £3 of the cost of pension tax relief relates to public sector DB schemes such as those for teachers, nurses and civil servants, and most of this is on employer contributions; in the private sector, members can put off a big pension tax charge by asking the scheme to pay the bill now in return for a lower pension later; but in these ‘unfunded’ public sector schemes there is no ‘pot’ from which the scheme could pay; so either public servants would face large up front tax bills or the Treasury would get little or no upfront revenue from taxing contributions to these schemes;
- Current levels of pension saving are widely agreed to be inadequate, and further cuts to pension tax relief could undermine pension saving; with traditional Defined Benefit schemes largely closed in the private sector and contribution levels into newer Defined Contribution schemes still at relatively low levels, action is needed to boost overall pension saving rather than to discourage it.
Karen Goldschmidt, a pension tax specialist at LCP, concluded: “The Chancellor will undoubtedly be looking with great interest at the quoted headline figure of £41.3billion for the ‘cost’ of pension tax relief. But these figures provide no excuse for a Budget raid on pension tax relief.
“The growth reflects millions more workers savings towards their retirement and should be welcomed, not used as an excuse for cuts. In addition, a large part of the headline cost of tax relief relates to the cost of public service schemes, where a reduction in relief would either result in big tax bills for public servants or generate little up-front revenue for the government.
“The tax relief figure also includes the vital contributions which firms are making to cover the shortfalls in their pension schemes which the government should be encouraging rather than taxing more heavily.
“Overall we need more pension saving, not less, and a raid on pension tax relief would send entirely the wrong signal to millions of people who have just started out on their pension saving journey.”
While it remains to be seen what the Chancellor will announce at the next Budget, which is due on October 27, Mr Sunak has assured he will “set out how we will continue to invest in public services and drive growth while keeping the public finances on a sustainable path.”
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