A policy paper prepared for the Liberal Democrat party conference signals a departure from the party’s old policy of wanting to cut pension tax relief for anyone earning more than the 40 per cent tax threshold (currently £41,450), according to Towers Watson, a leading global professional services company. Instead, the paper proposes to cut the lifetime limit on tax-relieved pension savings from £1.25 million to £1 million. The new Liberal Democrat paper also rejects three attacks on pensions tax relief that the party listed as options, with varying degrees of enthusiasm, in a spring 2013 consultation paper. These were: cutting the annual limit on tax-relieved pension contributions from £40,000 to £30,000; reducing the tax-free lump sums that can be taken from pension pots – either to a lower proportion than 25 per cent of the total or by capping the cash amount; and making employers and employees pay National Insurance Contributions (NICs) on the money that employers contribute to employees’ pensions.

At the 2010 general election, the Liberal Democrat manifesto proposed ending the practice of giving tax relief on pension contributions at the taxpayer’s marginal rate. Instead relief would be given ‘only at the basic rate, so that everyone gets the same tax relief on their pension contributions’. The party’s new policy paper says that ‘while the Liberal Democrats still recognise the merits, in principle, of moving to a single rate of relief, there are significant practical obstacles to such a proposal… therefore, we support limiting lifetime relief as a more effective way of restricting the pension tax relief given to the wealthiest’. Jackie Holmes, senior consultant at Towers Watson said: “Scrapping higher rate tax relief is much easier said than done. This is a policy with lots of noisy cheerleaders but there has always been less enthusiasm amongst those who would actually have to implement it.

“The realities of governing appear to have made the Liberal Democrats go cold on the idea and it’s not difficult to see why. To make this work, the Government would have to make millions of higher rate taxpayers pay tax on the money that their employers pay into pensions for them. Further calculations would be involved for public sector employees and others in defined benefit schemes, because it is the value of the pension promise that would need to be taxed, not the employer contribution. “This is an example of politicians sensibly performing a u-turn when the road turned out to be less traversable than they had imagined. Hopefully the Liberal Democrats’ conversion means that we can get through at least the next two Budget cycles without the usual scaremongering about the imminent demise of higher rate tax relief.”

The Lifetime Allowance was reduced from £1.8 million to £1.5 million in 2012 and is being cut to £1.25 million from April 2014. Pension savings above these limits are subject to a tax charge when they are brought into payment. The Liberal Democrat paper proposes a further cut to £1 million. Based on recent annuity rates, it says this would be enough to provide a tax-free lump sum of £250,000 plus an index-linked pension of £25,000 per year for a single man retiring at 65 in good health. Jackie Holmes said: “The last cut to the lifetime allowance has not even come in yet but another reduction is already being talked about. The lower this limit goes and the more times it is cut, the harder it will be for higher earners to plan for retirement. Unfortunately, it’s inevitable that aspects of the pensions tax system will remain unpredictable: politicians looking for revenue from the better off may find it easier to target their ability to save in pensions than their houses and other assets. “The rule that the taxman uses to value defined benefit pensions means that a £50,000 annual pension is treated as being worth £1 million. Some higher earning public sector employees would therefore have to come out of the scheme or face a tax charge if the Liberal Democrats persuaded their coalition partners to adopt this policy.

“When the Lifetime Allowance has been cut before, people have been allowed to preserve a higher limit for themselves on condition that they stop making new contributions. We presume the Liberal Democrats would want to repeat this, but it is not spelt out. They also do not say whether a reduction to £1 million should be regarded as the final cut, as they suggested when this idea was first floated earlier this year.” The Liberal Democrat consultation paper published in the Spring said ‘we are considering further reductions in the annual and lifetime allowances – perhaps to around £30,000 and £1m respectively,’ and asked if these were the right levels. The new policy paper says ‘we propose to retain the existing £40,000 annual allowance, in order to protect individuals who may only make sporadic pension contributions during their working life due to irregular income patterns, such as entrepreneurs’.

Jackie Holmes said: “The Coalition partner that was reported to have agitated for further cuts to the Annual Allowance now says this is not their preferred approach. While it looks as though no further cuts to the annual allowance should be expected this side of the election, that can’t be completely taken for granted. It will depend on the public finances and on how easy the Coalition partners find it to agree on other measures should they need to raise revenue.” The Annual Allowance was cut from £255,000 to £50,000 in 2011/12 and will fall to £40,000 in 2014/15. A tax charge applies to annual pension savings above that level, but there is scope to carry forward some unused allowances from recent years.

The new paper says ‘we…do not propose to change the 25 per cent tax-free lump sum which can be taken out of the pension pot upon retirement’. This decision follows the March consultation paper, which asked: ‘do you support changing the amount available as a tax free lump sum? What would be a reasonable level – either in terms of a reduced percentage or a fixed amount?’ However, it recognised that ‘any change in this area needs to be carefully considered in light of the financial plans that people have already made’. The March paper also asked ‘do you think that pension contributions made by employers should be subject to NICs?’ while acknowledging that this ‘would most likely lead to reduced pension contributions from employers’. The new paper proposes extending NICs to some taxable benefits in kind but not to employer pension contributions. Jackie Holmes said: “Restricting lump sums is just about the most visible change to tax relief that a Government could make, and support for this idea only sounded lukewarm to begin with. Trying to charge NICs on employer pension contributions can run into some of the same obstacles that did for Liberal Democrats’ plans on higher rate tax relief.”