Rules on pensions are not always black and white in the eyes of savers, but they are proving to be a handy revenue-raiser for government.
Tighter rules that limit the amount of tax relief available on pension savings are proving to be a money-spinner for the Treasury. According to data released by HMRC, around 2,400 savers breached the pension annual allowance in 2016/17, paying £53 million in tax.1
The annual allowance restricts the amount that you can put into your pension tax-free each year. It is currently set at £40,000 for many higher rate taxpayers, but a new rule introduced in 2016 means that the annual allowance reduces by £1 for every £2 earned over £150,000, dropping to a hard floor of £10,000 for those earning more than £210,000 a year.
Savers will usually pay tax at their highest marginal rate on any savings above the annual allowance, which is collected in two ways: either direct through the ‘scheme pays’ approach, or through self-assessment. As the name suggests, ‘scheme pays’ is when the pension scheme pays the whole or part of the tax to HMRC on your behalf. In other cases, you must pay the tax charge to HMRC directly.
The £53 million collected so far only includes money received through the scheme pays arrangement. Because self-assessment returns for the 2016/17 tax year will not be received by HMRC until January 2018, the final tax-take is likely to be higher.
“The annual allowance is frequently misunderstood, but the complication of the tapered annual allowance is a mystery for many pension savers – even experienced investors,” says Ian Price, divisional director at St. James’s Place. “The calculations that determine whether you are affected by the taper are best left to a financial adviser or accountant; those going without advice can easily make the wrong assumptions and they run a greater risk of incurring a tax charge.”
Yet the annual allowance is not the only way that the government curbs pension saving. It imposes an additional control called the ‘lifetime allowance’ (LTA) and it too is an earner for the government.
In 2015/16 the Treasury took almost £36 million from people who breached the LTA. This is up from £20 million in 2014/15.2
The LTA represents an overall ceiling on the amount you can build up in a pension, including the value of any defined benefit (final salary) schemes you belong to. Anything over the LTA is taxed at up to 55% when you take the excess as a lump sum, and at 25% on top of your marginal rate of tax when you take it as income.
In 2011/12 the LTA was set at £1.8 million, but successive cuts have trapped many savers; the reduction in the LTA from £1.25 million to £1 million in April last year has left thousands more individuals potentially within its grasp.
“With the reduction in the lifetime allowance to £1 million, more people will have to look at other options they have to fund their retirement,” says Ian Price. “If they’re going to exceed the lifetime allowance, then it makes sense to firstly stop paying into a pension. They should then work out just how much income they are going to need in retirement, before calculating any shortfall between this amount and what is realistically achievable from their pension fund.”
“To fund any shortfall, they’ll need to look at alternative investments. With the annual limit now set at £20,000, Individual Savings Accounts [ISAs] can be a useful vehicle to help recover this ground.” says Price.
“The key to all of this is to take advice to help understand exactly what you want and need at retirement, and then decide on the most appropriate investment strategy to get there.”
The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.
1. www.citywire.co.uk, 3 August 2017
2. Treasury data, accessed 7 August 2017