The upcoming Budget is unlikely to be a particularly uplifting experience. Signs are that chancellor Philip Hammond will have his work cut out to balance the books, in the face of seriously disappointing productivity growth – a measly 0.2 per cent a year over the past five years, according to the Office for Public Responsibility – and with investment hamstrung by Brexit uncertainties.
That means he will be looking for easy targets to replenish his coffers. With such a narrow majority in Parliament, he probably has little leeway as far as raising headline rates of income tax, national insurance or VAT is concerned, so once again the pension industry will be on tenterhooks in anticipation of further tinkering.
Earlier this summer, the Work and Pensions secretary David Gauke ruled out ‘fundamental’ reforms to the pension system; but as Aegon’s Steven Cameron points out, there’s a deep-seated clash of pension perspectives in Whitehall. ‘While the Department for Work and Pensions (DWP) sees pension saving as something to encourage, the Treasury views it as a drain on revenues,’ he sighs.
And not without reason, given that total pension tax relief (including income tax relief and employer national insurance exemptions) now costs almost £54 billion a year according to the latest HMRC data, having risen by £5 billion over the 2015/16 tax year alone.
The DWP and the pension industry see such outlay as a longterm necessity – ‘a huge investment in our future prosperity’, as Old Mutual Wealth’s Jon Greer puts it. Most individual pension savers would concur with that. All should be keeping their fingers crossed that come Budget Day on 22 November the chancellor will, in Greer’s words, ‘recognise the long-term value it delivers in helping workers achieve a saving pot that will deliver a prosperous retirement’. But for the Treasury, pension tax relief is a large, growing and ineffective area of public spending.
It’s very unlikely, though, that tax relief on pension contributions will be radically reformed – it’s just too massive and complex a job, especially with the Brexit clock ticking so insistently. More likely is further fiddling with pension tax limits.
The lifetime allowance (LTA), currently £1 million, might be trimmed without too much public outcry, but Cameron says the government would be guilty of very unjoined-up thinking if it took that step. For a start, the previous cut (in 2016) came with a promise to increase the LTA in line with inflation from next April.
Moreover, says Cameron, recent research by Aegon into the vexed question of how long-term care should be funded for/by elderly people revealed that the most popular choice for making personal provision in advance, cited by more than 40 per cent of respondents, was to use their pension. If the government were to bite the bullet and take a big-picture view of how to support the UK’s ageing population, that finding suggests it should be increasing the allowance rather than cutting it.
Another possibility is to introduce national insurance contributions (NICs) on employers’ pension contributions. These are currently exempt from NICs, depriving the Treasury of around £15 billion a year, and that sum will go up when minimum contributions to auto-enrolment schemes rise in April 2018 and 2019. Even a NIC of 1 per cent would raise about £1 billion a year, according to Steve Webb at Royal London.
It’s a radical option. Cutting NIC relief would heap additional cost on corporates and disincentivise them from boosting their pension contributions above the bare minimum required (thereby also discouraging employees from paying in extra). It’s even less appealing, given that employers will anyway face bigger auto-enrolment bills come April. But it would reduce the cost of pension tax relief without hitting employees directly.
If he takes this route, Hammond needs to consider the impact on UK businesses in the UK, warns Greer. ‘The Conservatives have already promised that the UK is open for business, a promise of particular importance as Brexit negotiations tick along,’ he observes. However, Hammond’s most likely target is the £40,000 annual allowance. Webb says: ‘With the Isa limit up to £20,000, the chancellor may ask if people really “need” to put £40,000 in a pension.’ But relatively few people are in a position to pay the full allocation into their pension each year, which suggests that while a reduction in the annual allowance may be the least damaging pension-related option for raising revenue, it’s also likely to be the least effective.
Another option, according to Andrew Tully of Retirement Advantage, is to reduce the hideously complicated tapered annual allowance that currently kicks in for those earning more than £150,000. It could be pulled back to kick in for those on incomes of £100,000 and above, thereby neatly targeting the relatively wealthy.
The bottom line is that the government, with such a narrow hold on power, will be nervous of doing anything controversial with headline tax rates to raise funds. The bowels of the pension system offer richer pickings, but the danger is that they will be at the expense, once again, of long-term retirement savings security.
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