Contractors will be hit hard if Webb gets his way

Calls to change tax relief on pensions contributions seem to be almost perennial, but perhaps contractors should take note of the latest one as it’s been sounded by the pensions minister himself, writes Tony Harris, IFA at ContractorMoney.

In fact, Steve Webb has publicly supported a proposal to replace the current tax relief regime with an effective rate of 33 % for all savers, regardless of their rate of taxation.

The pensions minister did attach a caveat to this, however, saying that “clearly it is not government policy, it is not even Lib Dem policy yet, but I’m working on that”. 

Although the proposal is only at an early stage, and is being widely viewed as a deeply political move, this potential change would impact ContractorUK readers who are building a nest egg.

What is pensions minister Steve Webb proposing?

Mr Webb is being influenced by Michael Johnson, Centre for Policy Studies pensions expert and part of the think-tank behind this plan. He proposes sweeping away today’s income tax relief based regime and has highlighted what he views as a fundamental flaw in that “income tax is progressive, so tax relief is inevitably regressive”.

Johnson believes that the present system is ineffective and not in the nation’s interest, and that policy is failing to instil a savings culture in the UK. Reform is deemed all the more necessary after the recent Budget, which no longer requires contractors to purchase an annuity, allowing retirees to have the flexibility to fully encash their pension pot.

The eight proposals

• Tax relief on pension contributions should be replaced by a Treasury contribution of 50p per £1 saved, up to an annual personal investment allowance of £8,000 and paid irrespective of the saver’s taxpaying status.
• The annual allowance should be set at £8,000 with prior years unutilised allowances being permitted to roll up, perhaps over as much as ten years
• ISA and pension products should share an annual combined contribution limit of £30,000 available for saving within ISA or pension products (or any combination thereof). This would replace the current ISA and pensions tax-advantaged allowances.
• The 25% tax-free lump sum should be scrapped, with accrued rights to it protected.
• The Lifetime Allowance should be scrapped. It adds considerable complexity to the pensions landscape, and with a £30,000 combined contributions limit for pensions and ISAs, it would become less relevant over time.
• The 10p tax rebate on pension assets dividend income which was controversially scrapped by Gordon Brown when he was chancellor should be reinstated.
• People should be able to bequeath unused pension pot assets to third parties free of Inheritance Tax (perhaps limited to £100,000), provided that the assets remained within a pension framework.

Politics, upheaval and unions

Our view is that the existing rules on pensions tax relief have evolved over decades into an unwieldy mess. However proposals announced at Budget 2014 appear to have resolved much of the disincentives to save. It is therefore going to be very interesting to see, precisely, how these new proposals increase the overall amount saved. We actually think Mr Webb’s plan, which some regard as an early policy kite for the election, is more about redistribution of tax relief than upping the total amount saved.

As an example of just one area of contention, pension contributions from employers should be treated as part of an employee’s gross income and should be taxed as such. As IFAs, our view is that this proposal is a clearly massive potential change to the current savings landscape, and it cannot be underestimated how dramatic an upheaval this would be because, for example, society has become so used to some employment having a very good pension to offset quite low salaries. Public sector workers are a case in point. If employer pension contributions are to be taxed as income, one can’t really imagine the unions accepting this.

How will contractors be affected by a 30% flat rate?

Contractors should be able to benefit from the 33% tax relief on up to £8,000 of investment. To many consultants, a £12,000 gross contribution would represent more than enough scope to invest, but we do have a large number of clients who are contributing far more than this because of the obvious current tax breaks that pension investment can attract.

Many freelance professionals will look on pensions as a very effective way of getting money from their contract and into their personal hands. Indeed, we have clients who are literally investing, using the ‘carry forward’ rules, all of their annual contract without having to pay chancellor George Osborne a penny.

As freelance contractors will have mostly job-hopped in their careers, they won’t have built up a large legacy pension pot that they can rely on, as ‘permies’ will be able to. Now that they are freelancing entirely, such savers will look to make up for lost time but the proposed limit that will curtail tax relief is going to potentially hit these contractors hard.

Groundhog Day

This is not the first time that a story has hit the mainstream press with regards to changes to higher rate pension tax relief and this does seem to be a perennial story for the nationals to run. However, the fact that Steve Webb, in his role as pensions minister and as part of the Conservative-LibDem coalition, has suggested this equalising of tax relief on pension contributions could now make for a very interesting Autumn Statement 2014.