The Budget: More Than Meets the Eye

Martin o’Gorman, VitalityInvest Pensions Technical Analyst

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Nov 29, 2018
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This year’s Budget was delivered at a time of relative uncertainty, with Brexit looming on the horizon. That, and the fragile government majority, may have been contributing factors to the general absence of any pension-related changes in the Chancellor’s speech. Whilst there was a funding commitment to the Pensions Dashboard project and a response to the consultation on the proposed ban on cold calling for pensions, the widely-speculated changes to the Annual Allowance did not materialise.

Some of the proposals do however have an impact on savers, and the Chancellor missed an opportunity to correct an inequity in the way pension tax relief is administered. Indeed, in some cases the problem has been compounded by the changes.

Good news for tax on income… 

From April 2019, the tax-free personal allowance will increase from £11,850 to £12,500, while the higher-rate tax threshold of 40% will also rise from £46,351 to £50,000. Both thresholds will remain at the same level until the end of 2021, and thereafter will increase in line with the Consumer Price Index. The Policy Paper identified that this measure will benefit 30.6 million individuals, of whom 26.2 million will be basic rate taxpayers and 4 million are higher rate taxpayers.

Bringing the changes to the threshold forward by a year means that 499,000 individuals will now pay no tax at all and around 479,000 individuals drop out of the higher rate of income tax in 2019. For someone earning £50,000 the changes equate to a saving on average of £860 in tax. When the uplift to the high rate threshold for National Insurance is taken into account, the net position is a saving of £380.

… but bad news for ‘net pay’ pension scheme members 

When it comes to pension saving, the changes mean that 479,000 individuals will now potentially lose an additional 20% tax relief that they will have been eligible to claim on their contributions. But the bigger impact will be felt by those people at the other end of the scale, who are subject to the ‘net pay’ anomaly. What has been described by some commentators as a “huge injustice”, impacting some 1.2 million pension scheme members, arises for individuals who earn below the tax-free personal allowance. They are entitled to relief on pension contributions up to £2,880 a year. Where the pension scheme operates on a ‘relief at source’ basis, contributions automatically benefit from the 25% uplift, potentially increasing contributions to £3,600. 

However, where the scheme operates on a ‘net pay’ basis the contribution is deducted from salary before tax is calculated, so any members earning below the £12,500 personal allowance won’t benefit from the uplift. The vast majority of workplace pension schemes operate on a net pay basis and where low earners are captured by the Auto Enrolment obligations they are not getting the same tax relief that should be granted automatically. 

Case study

Paul works part-time earning just under the personal tax allowance of £12,500 per annum and automatically enrolled into his employer’s scheme paying a 5% employee contribution. Under the ‘net pay’ arrangement his gross contribution, £50 per month, is deducted from salary prior to tax and NI being deducted. If Paul was in a scheme operating Relief at Source the net contribution is deducted from net pay.

As Paul does not pay tax on his earnings the ‘cost’ of membership under the net pay basis is an additional £124 a year. 

Net pay basis
Gross Salary - £1,040
Less Pension contribution - £52
Less tax - £0
Less NI - £38.52
NET Pay - £949.48
Relief at source basis
 Gross Salary - £1,040
 Less tax - £0
 Less NI - £38.52
 Less net contribution £41.60
NET Pay - £959.88

In relief at source basis, employee will get tax relief of £10.40 so that the amount invested in the pension is £52 in both scenarios.


Kicking the can down the road 

So while the increase in the personal allowance will benefit low earners, for those in net pay schemes they will now have to pay an extra 25% to bring their pension contributions up to the ‘Relief at Source’ equivalent. From an individual’s point of view, this distinction is significant. It is also essentially arbitrary, being based entirely on how their pension scheme is constituted. With a growing awareness of the saving gap that people are expected to face at retirement, it is a key area of pensions policy that the Government needs to address.

 

For Investment Professionals only.

VitalityInvest is a trading name of Vitality Corporate Services Limited. Vitality Corporate Services Limited is authorised and regulated by the Financial Conduct Authority.

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