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Summer Budget: Pensions tax relief reform on the way

The chancellor has raised the prospect of scrapping upfront pensions tax relief altogether
Summer Budget: Pensions tax relief reform on the way

The chancellor did not make the widely expected cuts to higher-rate pensions tax relief. Instead, he launched a consultation on reforming pension tax incentives that includes the option of scrapping tax relief altogether.

In the foreword to the Pensions Green Paper, George Osborne states: "At the heart of the current system is a simple principle: the contributions you make to a pension during your working life are tax-free, and you pay tax on them when you come to take your pension."

The paper states that more than two-thirds of pensions tax relief goes to higher-rate and additional-rate taxpayers and the "gross cost of pensions tax relief is significant" - £50bn in 2013-14. But it makes clear that "the current system of pensions tax relief does not sufficiently help to foster engagement and understanding of pensions".

The paper raises the possibility of scrapping upfront tax relief altogether to make pensions more like individual savings accounts (Isas), together with a government top-up at a later date.

Claire Trott, head of pensions technical at Talbot and Muir, says: "Any kind of consultation where the outcome isn't already predetermined is a step forward from a government telling the industry how to run pensions when they don't necessarily understand the implications."

John Fox, managing director of Liberty SIPP, says: "The Green Paper will scare the life out of many traditional pension providers, but innovation, change and empowering people to save in the way that suits them best, are key to defusing the pensions time bomb.

"Making pensions more like Isas is another potentially radical step and has come while the industry is still coming to terms with the new pension freedoms."

Faced with a Pensions Green Paper, high earners should take a good look at their pension savings and consider whether they want to pay any further pension contribution before April 2016 to get the full tax relief, especially if they have benefits well below £1.25m which can then be protected against the reduction in the lifetime allowance.

Meanwhile, the Summer Budget confirmed that the Treasury will reduce the amount that people with an income of more than £150,000 can pay tax-free into a pension. Most people can contribute up to £40,000 a year to their pension tax-free. However, annual allowances for savings will be tiered on earnings between £150,000 and £210,000, with those earning £210,000 seeing their annual allowance cut from £40,000 to £10,000.

This move will pay for an increase in the inheritance threshold to £1m to allow people to pass the family home to children and grandchildren.

Andy Cumming, head of advice at Close Brothers Asset Management, says: "Paying for the change through cutting pension tax relief to high earners runs contrary to the spirit of the recent pensions reforms. We need to be encouraging greater pension saving across the workforce, and limiting the amount one section can set aside will not help build a nation of savers. The shrinking lifetime allowance has already penalised long-term pension saving, and this move compounds the policy error."