Pensions are supposedly a stable longer term savings environment to ensure individuals can have certainty of income in retirement. But another significant change to pensions announced in the Summer Budget means that action is required and other options may need to be considered urgently.
Chancellors in recent years have each made changes to the pensions rules, making it difficult for individuals to plan for the future. The positive trend of providing flexible access in retirement can be contrasted with the negative restriction of tax relief on contributions for those who can benefit most (ie high earners).
The latest changes continue this trend of instability and the Chancellor even went further, announcing a consultation on the entire pensions regime which could see a completely new system for retirement saving introduced in the future. Suggestions include a completely flexible savings system, similar to the current ISA regime, which would see no tax relief on contributions and no tax on withdrawals, but the continuation of a tax free growth environment. We will have to wait and see where that goes.
For now, we know there have been some technical changes around pension input periods and the annual allowance for contributions where individuals are also drawing on pension funds under the new flexible drawdown rules.
However, the major change has been the announcement that the annual allowance for contributions will be restricted to an amount below £40,000 for those whose income is more than £150,000. The restriction will apply from 6 April 2016, with a £1 reduction in relief for every £2 of income above this threshold, until the allowance has been reduced to £10,000. That minimum annual allowance will apply to all those earning £210,000 or more.
So the question is what can be done if the allowance is restricted? Here are some of the possibilities:
- Maximise pension contributions this year – Pension contributions for the current year (ending 5 April 2016) are unaffected by the rule changes and, of course, any unused relief from the prior three years can still be utilised (once the current year’s allowance has been used) starting with the oldest year. That means unused relief from 2012-13 can be used in the current year, once the £40,000 current year allowance has been used. Important things to consider when maximising relief are:
- Is there enough relevant income to ensure maximum tax relief in the year? It may be better to use the old unused relief across the next few years rather than in just one year, subject to ensuring that unused allowances for the earliest prior years are not lost.
- How do you fund the contributions? It may be that borrowing to fund contributions is the right investment decision; that could be borrowing from the bank, your business or elsewhere, but tax and investment advice should be taken.
- Think of the family – If there is no personal unused relief or if maximising relief may mean that the lifetime allowance is exceeded, it may not make sense to make further contributions. Perhaps a spouse has an underused pension allowance which could be maximised instead going forward, providing a joint income in retirement. The spouse’s earnings and historic pension arrangements will need to be considered.
- Consider alternatives – It might be that pensions no longer provide the route for long term savings. Over £30,000 can be saved by a couple into ISAs annually and, while no relief is given on the contributions, the investments are in the same tax free environment for growth as pensions and suffer no tax on withdrawals. There are also tax efficient investments which give immediate relief on contributions, such as the enterprise investment scheme (which gives 30 per cent tax relief on investment as well as capital gains reliefs) and venture capital trust investments which just give the 30 per cent income tax relief. Of course, these are riskier investments, which is why the tax relief is offered. Other ‘wrappers’ for saving may also provide good alternatives, such as offshore bonds or personal investment companies.
While the changes in pension contributions could be restrictive, these other options are available and mean that the ‘norm’ for many of pensions saving for the long term is no longer the default position.
However, with so many options and the continued uncertainty, good joined up tax and investment advice will be needed.