The Budget is coming – possible changes to tax treatment for pension contributions

As you will be aware the Chancellor has brought forward the date for this year’s Budget. It will now take place on Monday 29 October. There is the usual speculation that he will make changes to the tax relief available on pension contributions – but many analysts think that he is more likely to do something this time as his opportunities to raise tax revenues elsewhere are quite limited, and there are some well-known and well-publicised spending commitments to fund.

But the Government (or rather HMRC) has already announced (in response to a clamour from a number of well-known campaigners, including former ministers) that it is looking at ways to address one tax anomaly and this would help those who fall below the current tax threshold and are in net pay pension schemes.

The anomaly arises, when compared to what are known as relief-at source schemes, because under those schemes the contributions are deducted after tax has been applied, and HMRC then pays the 20% tax back to the scheme (or the provider). This is then added to the saver’s pension pot. Under a net pay scheme the contributions are deducted before tax is assessed – so if the employee does not pay tax (because earnings are below the tax threshold, currently £11,850) he will pay get no benefit at all from HMRC.

Put simply an employee earning above the threshold will get £100 in their pension pot at a net cost of £80 but the net cost to a non-tax payer is £100.

Possibly at the other end of the spectrum, the speculation on tax relief on pension contributions is focusing on two areas, either:

• Moving to a flat rate of tax relief regardless of the employee’s marginal tax rate – suggestions are either 25% or 30%, both of which would help basic rate tax payers but cost higher rate tax payers more; or
• Reducing the annual allowance, currently set at £40,000.

Both measures would increase the cost of pension savings for higher rate tax payers.

It is not clear how or whether salary sacrifice arrangements would be affected by any change to a flat rate of tax relief. Employer contributions count towards the annual allowance so it does not matter if the contributions are made using salary sacrifice. However some additional measures would be needed to deal a reduced tax relief rate with salary sacrifice.

So some changes are almost certainly on the way. The details and timing are not yet known but there will be the inevitable changes to payroll, potential impact on costs, and some challenging communications issues to deal with for at least some employees.