Pension tax relief, the new Chancellor and the 2020 Budget

Promises made in the Conservative manifesto mean that changes to pension tax relief are highly likely to feature in the 2020 Budget. The manifesto specifically promised:

• To tackle issues around NHS doctors facing large and unexpected tax bills;
• To address an anomaly which means that well over a million low paid workers miss out on a pension tax break enjoyed by other workers on similar wages;

However, the new Chancellor could choose to take advantage of a large Parliamentary majority to introduce more fundamental reform which could raise significant sums. Against this backdrop, a new paper from pension consultants Lane Clark & Peacock LLP published today (Wednesday 26th February) examines the likely options and considers the pros and cons of each.

Key findings include:

• Introducing a single ‘flat rate’ of pension tax relief would be a highly complex reform which would require consultation on the details and could not be implemented quickly. With over 4.2 million people paying income tax at the higher or additional rate, many of whom will be saving into a pension, there would be large numbers of losers and average losses could run to thousands of pounds.
• If the March 2020 Budget floated major cuts to tax relief to be implemented in future years, this could lead to people seeking to ‘max out’ on pension saving ahead of any change. Without additional temporary rules in the meantime (known as ‘anti-forestalling measures’) to prevent this from happening, the government could see a significant loss in income tax revenue as pension saving increased ahead of any changes.
• The new Chancellor has a variety of options for delivering on the manifesto pledge to tackle issues around higher earners (such as NHS doctors) and limits on pension tax relief, in particular the tapered annual allowance. These include:
  
  • Minor ‘tweaks’ to the thresholds at which stringent limits (the so-called tapered annual allowance) on pension tax relief are applied; whilst these would reduce the numbers affected, they may not be enough to reassure doctors that they are no longer at risk of tax bills for taking on extra duties;
  • Abolishing the ‘tapering’ of the annual allowance altogether – this would be a bolder reform and would simplify the tax system; but the Treasury would be likely to recoup the lost revenue, possibly through an across-the-board reduction in the £40,000 annual allowance; this would in turn create losers amongst those not currently affected by the annual allowance;
  • Excluding ‘defined benefit’ pension growth completely when testing against the annual allowance, in line with the demands of the British Medical Association; the Government may however need to take steps to prevent those who benefit from this change from getting extra tax relief through making contributions to ‘defined contribution’ pension arrangements as well; it is hard to see how this change would work for schemes where people build up both ‘defined benefit’ and ‘defined contribution’ rights at the same time;
  • The manifesto pledge to tackle the issue around low-paid workers missing out on a ‘tax credit’ on their pension contributions is unlikely to be resolved in this Budget. The manifesto simply promised a ‘review’ and potential solutions are not straightforward.

Commenting, Steve Webb, partner at LCP said:

"The new Chancellor could make his mark by simplifying a hideously complex system of pension tax relief. The rules for higher earners are especially challenging and have already had unintended consequences in the NHS and elsewhere. A decision to abolish complexities such as the tapered annual allowance would improve matters both for taxpayers and those who have to administer the system. However, a more fundamental reform such as moving to a single flat rate of tax relief would add complexity, especially for those building up Defined Benefit pensions – including most people in the NHS. Whilst finding additional revenue by cutting pension tax relief is an alluring prospect for chancellors, there is a risk of creating millions of losers and adding to an already complex system."

Alasdair Mayes, LCP partner and pension tax specialist said:

"There is a risk that changes to the pension tax relief system to address individual issues simply create new complexities. There is a strong case for reviewing tax relief systematically to see if it is achieving its desired objectives rather than purely seeing it as a source of easy revenue. Some of the problems which the Chancellor will now need to address have arisen in the first place because of incremental piecemeal reform. It is important that the ‘solutions’ to these problems deliver a system which is simpler and more predictable than the current one."