Potential cost to Treasury of £6 billion if they don’t introduce anti-forestalling measures on the day. Higher earners set to lose £000s in relief Opportunity to maximise pension funding over next 2 months. Hargreaves Lansdown comment Tom McPhail, Head of Retirement Policy.

‘We have always viewed a flat rate of relief this as the most likely outcome. Logically, if the Treasury is going to announce a flat rate system for the future, they’d have to bring down the shutters on 16 March, in order to prevent wealthy investors from grabbing any last share of the higher rate relief before it is abolished. If they didn’t do this, we estimate that it could cost the government an extra £6 billion within just a few weeks. Any higher earners who are looking at paying into a pension, should think seriously about doing so before 16 March. Conversely, for basic rate taxpayers, it may make sense to wait until after that date.’ 

‘Any changes of this nature should also be accompanied by the abolition of the Lifetime Allowance and the Annual Allowance Taper, both of which are heavily bureaucratic; the Lifetime Allowance is also a penalty on good investment performance, which is surely not what good policy should look like. ’ 

What rate of incentive might the government introduce?

It would have to be higher than basic rate and lower than higher rate. We recommended 33%, in other words, for every £2 you pay into a pension, the government would pay in £1. Other likely options include 25% (you pay in £3, the government pays in £1), or 30% (you pay in £7, the government pays in £3). 

What might the Treasury do?

They could simply announce that from 16 March, no new pension contributions would be eligible for higher rate relief. Anyone who made a contribution after that date would be ineligible to claim extra relief through their tax return. Higher and additional rate taxpayers contributing to certain company pension schemes would suffer additional tax charges of 20% and 25% on each contribution respectively. 

What about Net Pay Schemes?

Some schemes are set up on the basis of pension contributions being deducted from employees’ gross pay (confusingly, this is known as ‘Net Pay’). It would take time to shift such schemes across to a flat rate pension system. The government could announce that existing regular contributions through Net Pay can continue until April 2017, thereby giving employers and the industry time to adapt. Various parties involved in pensions (including the Pensions Minister) have become increasingly concerned about the fact that the Net Pay system can result in lower earners missing out on tax relief. 

A move to a flat rate incentive system would almost certainly be accompanied by a wholesale shift across to the other method of tax relief, known as ‘relief at source (RAS)’ whereby an investor makes a contribution net of the tax relief and the pension provider then claims a top up from the government. For example, under the current system, whereby tax relief is granted at 20% under the RAS system, a payment into a pension of £80 gets topped up to £100. If the top up rate were increased to 25%, then an investor would only have to pay in £75 to get it topped up to £100 by the government. 

What about Salary Sacrifice?

Salary sacrifice involves employees foregoing remuneration in exchange for an employer contribution into their pension. This might have to be addressed under the new flat rate system, for example higher earners might have to be taxed on the benefit of any employer contributions (though this could be applied only to contributions in excess of the auto enrolment minima). It could be possible for the employer to pay the tax charge on behalf of the employee. So for example, if a 40% taxpayer received a pension contribution from their employer of £100, under a flat rate system of say 33% relief, there’d be a £7 tax charge (the difference between the 33% top up rate and the 40% income tax rate); alternatively the employer could pay the charge for the employee, in which case it would have to grossed up by the tax charge, resulting in an additional charge of £11.66 on the employer. 

What other changes could we see?

We think a reduction to the Annual Allowance is also highly likely, possibly down to as low as £25,000. If the Chancellor is willing to continue with his policy of giving with one hand whilst taking with the other, then we might also see the abolition of the Lifetime Allowance. 

What would be the effect on individuals?

The following table illustrates the potential impact on investors under various scenarios: