Taxing times for pension savers - Guest Article by Mark Belchamber
In 2017/18 the amount of income tax relief provided to pension savers by HMRC is estimated at around £40 billion[1]. That’s a lot of money! And about 50% of that relief goes to just the top 10% of taxpayers[2].
There is a lot of speculation that the Chancellor will be looking at this with interest in the budget on October 29th.
Tax and pensions go hand-in-hand. Contributions to pensions are tax-free, most growth in your pension is tax free and when you take your benefits you can take up to 25% of the value of your pension tax free. That generally means that pension saving is a pretty tax-efficient way of saving.
But because the Government “gives” so much tax away there are restrictions on how much you can save into a pension. These restrictions limit your yearly savings; the Annual Allowance, and your total pension value; the Lifetime Allowance.
These two allowances were introduced in April 2006. Initially they were set at £215,000 for the Annual Allowance and £1,500,000 for the Lifetime Allowance and they replaced a very complex set of tax rules. This was known as Tax Simplification – hold that phrase in your mind!
Initially very few people were affected by these levels. However, the allowance levels have been reduced regularly. HMRC are now “saving” about £6bn in relief because of the allowances and their reductions – a lot of which was going to “subsidise wealthy people’s pensions”.[3]
The Standard Annual Allowance for the 2018/19 tax year is £40,000 and the Lifetime Allowance is £1,030,000. Significant amounts, and you may dream about this level of pension saving, but many people are affected by one or the other, or sometimes both of these.
There’s a sting in the tail for “higher earners” too. If someone has taxable income over £150,000 (which includes the amount saved into their pension) the Annual Allowance may be further reduced to as low as £10,000. This is known as the Tapered Annual Allowance.
Any pension savings that exceed the allowances are subject to tax charges.
Annual Allowance – it’s all about YOU!
For the Annual Allowance the tax charge is declared through self-assessment and tax is payable at your marginal rate. The point about self-assessment is that this means it is up to you to tell HMRC if you have tax to pay. How do you know?
Your pension scheme may tell you if your pension savings exceed the Standard Annual Allowance (they should do this by 6th October each year) but if you have several pension schemes or are affected by the taper they don’t have to do this – you will have to ask. They will send you a Pension Savings Statement that shows how much your pension savings are for the last tax year and the three previous tax years. It is up to you to work out if you have exceeded the Annual Allowance and/or if you are affected by the taper.
If you are it doesn’t stop there. You have to work out how much tax is due, and you have to declare the tax charge to HMRC and you must also pay the tax. You can pay HMRC directly, or you can ask if your pension scheme may be able to pay your tax bill for you (known as Scheme Pays) and (if they will) in return, they will reduce your pension to pay for the tax – how they do this depends on which scheme you are in – and there are rules about when they can do this and deadlines that you have to meet.
The onus is on you to do a lot of the work – (nearly ALL the work!)
Lifetime Allowance – not a limit on living!
Lifetime Allowance values can be estimated at any time but are only tested when you take your pension. This used to be known as “retirement” but now HMRC call these “Benefit Crystallisation Events” (BCE). Catchy name! There are about 12 BCEs and each represents a different way of you taking some or all of your pension; like taking a lump sum or buying an annuity or moving funds into drawdown. Each time you take some of your benefits you will use up part of your Lifetime Allowance and when you have used up 100%, any pension savings left, and any further BCE’s, are likely to mean a Tax Charge is due.
Your pension scheme or provider provide help here and they can work out the tax charge and can pay this to HMRC directly (on your behalf), again, reducing your benefits to recover the tax. There are two different tax charges depending on whether you take the amount above the Lifetime Allowance as a pension (tax charge of 25%) or as a single payment (55% tax charge). If you do take the excess amount as pension you will still pay income tax on the remaining 75%, so for higher rate tax payers this works out broadly the same as the 55% single payment rate. Ow!
Don’t forget the good bits
We see people regularly who focus on the tax charge and forget that behind this are still significant amounts of money that do benefit from tax-relief. It’s only the excess amounts that are taxed and saving £40,000 in a year into a pension can save up to £16,000 in tax for a 40% tax payer, so it only really costs you £24,000.
This is confusing! Is there any help available?
There is lots of information to help you understand the tax rules and most pension providers have factsheets and supporting materials on their websites. HMRC have a Pension Tax Savings Manual that describes all the detail you could possibly want – have some moral support to hand before diving into this! HMRC also have a calculator that you can use to test your Annual Allowance values and work out how much tax is due (if any).
Guidance and training is also available from consultancy firms and this can go a long way to getting you up to speed and being able to “self-assess” whether you need more help.
Accountants and financial advisors can also help you get to grips with the rules and walk you through the processes. But they may be expensive and you are likely to still need to roll your sleeves up and do a lot of the work yourself.
It’s a complex issue and you may question whether the term “tax simplification” was ever appropriate but many savers will never reach these allowance levels. For those that do I suggest “tax complification” is a better phrase!
The detail above is how the system currently works. If changes are announced in the budget we could see lower allowances, less tax relief and even more people affected. We can only hope that whatever happens is easier to understand.
Mark Belchamber has over 23 years’ experience helping people understand their pensions and is Director and founder of “Income for the Third Age Ltd”, a company that specialises in guidance and education for employers and employees on pensions, pension tax issues and retirement options.
[1] Source. Combined amounts for savings made to registered pension schemes and employer contributions. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/675345/Dec_17_Main_Reliefs_Final.pdf
[2] Source. Treasury select committee report published 28 July 2018. Household finances: income, saving and debt Chart 5.1
[3] Source. Treasury select committee report published 28 July 2018. Household finances: income, saving and debt Para 116
