Just as the pensions industry thought a semblance of predictability had been brought to the tax incentives of saving for retirement, the issue has blown up yet again.
Many experts had predicted that the introduction of the annual pension contribution allowance of £50,000 a year, and the long term fixing of the lifetime limit at £1.5m meant tax relief on pensions was not going to be touched for some time.
But George Osborne’s first Budget as Chancellor has given the go-ahead to one of the most significant changes to our tax structure ever introduced – a planned harmonisation of the operation of National Insurance and income tax.
The effects of such a change, whenever it is pulled off, could scarcely be more far-reaching, affecting a wide range of benefits, not just pensions.
Osborne pointed out in his Budget speech to the huge administration savings that could be got rid of by harmonising the two. But he does not appear to be calling for an outright abolition of NI, stating that the contributory principle would be maintained.
While details of implementation of the plan are notably thin on the ground, some experts predict the merger of income tax and National Insurance could lead to higher rate tax relief on pension contributions being scrapped altogether. From the beginning of the new tax year someone in the basic rate tax band for income tax will pay a total of 32 percent in tax, including NI, while someone in the higher rate tax band will pay a total of 42 per cent above their personal allowance. If they were merged, the government would be unable to give basic rate taxpayers 32 per cent while paying more to higher earners, but could decide to pay 32 per cent across the board, says Skandia.
The removal of higher rate tax relief on pension contributions has been rumoured for a long time and a merger of income tax and national insurance might prove to be the tipping point.
Adrian Walker, pension expert at Skandia, says: “The removal of higher rate tax relief on pension contributions has been rumoured for a long time and a merger of income tax and national insurance might prove to be the tipping point. This would be a poor outcome for investors who need as much incentive as possible to save for their retirement.”
More immediately pressing for some employers is the rising cost to DB schemes that will result from the Budget changes.
Eleanor Dowling, principal at Mercer, says: “Employers are likely to cut future accrual in DB schemes, since they will lose the funding that comes from rebates of National Insurance Contributions. Schemes already have to cope with removal of the default retirement age, and will now have to respond to a moving target State Pension Age, and proposals in this Budget to cut tax relief for employers who are using innovative asset-backed funding techniques. Of course, this is happening at the same time that companies are struggling to pay off considerable pension deficits, and the huge and complex pension tax relief changes that are being introduced.”
These changes will however facilitate the implementation of a state pension system of around £140 a week, although again, it appears we are in for a long consultation and implementation period for this to take full effect. The NAPF took the Budget announcement to grant itself a moment of self-congratulation on the adoption of the flat-rate pension, pointing out that it had proposed a foundation pension very similar to the model expected to be adopted back in March 2010.
Labour has welcomed the proposal but has criticised the government for not actually putting any proposals on the table yet. Pensions shadow Rachel Reeves says: “Yet again the Government have announced a ‘flat-rate’ pension with no details at all. All he has committed to is looking at a number of options for simplifying the State Pension system. The £140 a week proposal sounds like one of a number of options.”
Tied into the flat-rate state pension is an expected increase in state pension age, and the Chancellor’s indication that we should follow the Swedish model and link increases to longevity has been widely welcomed in the industry, although some warn the change could be used to jack up the retirement age more quickly, dependent on the way assumptions are made.
Joanne Segars, chief executive of the NAPF, says: “As people live longer, increases in the State Pension Age are a must. But they need to be handled fairly. As long as people are given enough time to plan for their retirement, making future changes to the State Pension Age more automatic, alongside independent reviews of longevity, seems a sensible way to proceed.
“But any new mechanism needs to handle future increases more fairly than the rise to 66 already proposed. 330,000 women in their late 50s will be particularly affected, experiencing an increase by as much as two years with little time to plan.”
Fairness will be a watchword for every single part of the debate. The onus is now on the politicians to make sure the whole is as fair as all of the parts.