An alternative approach to restricting pensions tax relief

The cost of tax relief on pension contributions doubled under the previous government to an annual cost of around £19bn by 2008/09. The government confirmed in the Coalition Budget that it is committed to reform of pensions tax relief and would continue with plans that it inherited to raise revenues from restricting pensions tax relief from April 2011.

The government had reservations about the previous plans. It felt that this approach could have unwelcome consequences for pension saving, bring significant complexity to the tax system, and damage UK business and competitiveness. These concerns were shared both by representatives of the pensions industry and by employers.

The June Coalition Budget announced that the government was considering an alternative approach to restricting pensions tax relief, involving reform of existing allowances. A discussion document on the subject ‘Restriction of pensions tax relief: a discussion document on the alternative approach’ was published in July, inviting views on a range of issues around the precise design of any such regime.

From April 2011 the government has announced the annual allowance for tax-privileged saving will be reduced from its current level of £255,000 to £50,000.

Tax relief will be available at an individual’s marginal rate. Deemed contributions to defined benefit schemes will be valued using a ‘flat factor’ of 16. Individuals will be allowed to offset contributions exceeding the annual allowance against unused allowance from the previous three years. For those individuals who see a very significant increase in their pension rights in a specific year, the government will consult on options that enable them to pay the tax charge out of their pension rather than current income.

According to the government, only around 100,000 individuals currently have annual pension savings above £50,000 – around 80 per cent of whom are on incomes above £100,000. The government anticipates that most individuals and employers will look to adapt their pension saving behaviour and remuneration terms following introduction of the new rules.

The lifetime allowance will also be reduced from its current level of £1.8m to £1.5m. The government’s intention is that the reduced lifetime allowance will operate from April 2012. It is inviting views on the detail of its approach, including the relative burdens for schemes and employers of implementation in 2011 compared with 2012.