Pensions cap may require you to readjust
QUESTION: How have the recent announcements in the Chancellor’s Pre Budget Report affected my pension planning?
ANSWER: The Pre Budget Report announced a number of measures aimed at re-starting the faltering economy. As with any fiscal policy, what is given on one hand is taken away or provided for by another.
One of the areas that have resulted in a “taking away” are pensions. The Chancellor outlined in his speech that the lifetime allowance individuals can hold within a pension scheme will be capped for five years after the tax year 2010/2011.
The amount which can be contributed into a pension scheme will also be frozen for the same five-year period.
In 2006, as a result of what were known at the time as “A day” changes, the then chancellor Gordon Brown made a radical overhaul of pension legislation. This was an attempt to simplify pension schemes and provide an equal playing field for all who wanted to save for their retirement, be it in a final salary pension scheme or a private arrangement.
At that time, he set out an amount that could be held within a pension scheme without additional tax charges.
He also set out an amount that could be contributed irrespective of age or pension scheme. Up until now those limits have been increasing each year, but his announcement has now signaled intent that automatic rises are gone.
While those allowances are set at a fairly high level i.e. accumulating a fund of £1.8m and allowing an employer to contribute £255,000 per year, this will make a difference to some. Many affected will be in final salary pension schemes.
The second announcement made concerned the increase in tax rate for those earning in excess of £150,000.This new rate of 45% may act as a spur for some pension savers as historically pension relief has been given at an individual’s highest tax rate. This could cause people earning over the new threshold to defer making pension contributions to gain from the additional five percent tax relief.
However, the government has yet to clarify whether additional tax relief will be given, or as some commentators suspect, will be capped at 40%.
Again looking further ahead, the increases in National Insurance will make salary sacrifice pension schemes more attractive. These make earnings contributed to a pension plan free from National Insurance as well as benefiting from immediate tax relief.
This will become more attractive not only because of the increased rate of NI but also given the fact that many more people will be caught in the National Insurance trap, created by the extension of the upper band earnings. So as with any legislative changes, it is important to sit down and review your current planning and strategy to ascertain whether or not any adjustments need to be made in light of these announcements.
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact firstname.lastname@example.org or (028) 9022-1010.