This week the chancellor delivered a well sign-posted budget, with many of the key pension constituents already known, but lacking final detail. The financial planning community welcomes these changes given all the variations introduced since George Osborne announced the pension freedoms in 2015. From tapering the amount you can save each year to restricting the pot size with successive reductions in the lifetime allowance, the attractiveness of pensions has been gradually eroded.
While much of the talk was about how the changes would encouraging over 50s back into the workplace, and keeping our needed senior NHS staff employed, motivated and not facing significant additional tax charges for just turning up at work, this now provides a huge opportunity to middle Britain.
The Tax Trap
For many, saving significant amounts into a pension during the early years of employment is not possible. Career building, mortgage payments, kids, and other expenses often come first, and the opportunity for compounding growth is lost. Lots of clients I look after delayed doing pension planning in earnest until their earnings or family commitments change, sometimes that goes hand in hand with moving into the higher or additional rate tax brackets.
From the new tax year, additional tax rate of 45% begins at earnings over £125,139. But this doesn’t tell the full story. When you consider the personal allowance of £12,570 is tapered from earnings above £100,000, this creates a tax trap of 60% tax on anyone earning in or above that bracket.
This is where pensions come to the rescue. They allow you to pay money into your pot and reclaim some or all of your taxes. Reforms to the pensions annual allowance taper are also helpful. They giv many higher earners the ability to pay £10,000 when previously they would be restricted to £4,000, and the increase annual allowance is crucial in giving many more people the ability to pay up to £60,000 per year.
In recent years, higher earning individuals have been forced to either pay the tax and invest into ISAs, or, if they have the appetite, look at higher-risk products such as venture capital trusts, enterprise and seed enterprise investment schemes, which carry a 30% tax relief if certain conditions are met. Such people might now be minded to review their position with immediate effect and consider increasing their pension contributions instead.
The Final Piece
The final piece of the puzzle is the complicated issue of the lifetime allowance (LTA). Abolishing this measure was the biggest shock, but removes a big bit of red tape, along with disincentives to carry on saving and investing for retirement. Many believed it was simply a tax on investment growth or making prudent investment decisions over time.
The changes should now hand early retirees (or potential early retirees) an incentive to stay in work longer or return to work, particularly if their family commitments have fallen away. Some people could be tax neutral in their final working years, providing they have enough savings or other income to bridge the gap. That means they could sacrifice all or most of their salary into pensions.
This has the net effect of making sure valuable skills, knowledge and experience isn’t lost from the workplace, with flexible working and lifestyle habits in the post Covid era, we can now build on the 2015 flexible rules to create wealth and prosperity. I very much look forward to the autumn statement, which will include additional allowable investments inside defined contribution plans.
In turn, bigger pension pots will mean larger drawdowns, creating tax revenue for future chancellors, not just from pots themselves but from the underlying corporation tax and VAT collected after spending in the real economy.
All in all, this week is a good day to be a pensions adviser. I’m now contacting my clients to advise them to take appropriate action.
Ian Cook is chartered financial planner at Quilter