Pension tax relief cut could cost higher earners thousands

Reduction of limit on pension tax relief from £50,000 to £40,000 will see more final salary pension holders caught in charges net

The widely trailed capping of pension tax relief will see the maximum amount anyone can pay into a pension over a year and still qualify for tax relief fall from £50,000 to £40,000. Combined with a cut in the maximum “lifetime limit” for pension savings from £1.5m to £1.25m, the move will save the Treasury £1bn.

The chancellor said the cut will hit a tiny number of pension savers, as 99% of people pay less than £40,000 a year into a pension, with the average only £6,000.

But tax experts warned that headteachers and GPs with final salary pensions could be caught in the net.

Under the rules, any payments into a pension scheme above the new cap of £40,000 will effectively be hit with a charge set at the individual’s marginal tax rate. For someone earning more than £150,000 in the 2013/14 tax year, when the top rate of tax will be 45%, the cost of contributing £50,000 into a pension scheme will rise by £4,500.

But already tax advisers are recommending alternative ways the rich will be able to shelter their income from HM Revenue & Customs. It is likely some of the money that would have gone into pensions will instead be switched into vehicles such as venture capital trusts (VCTs), which give savers up to 30% upfront income tax relief.

Patrick Reeve of VCT providers Albion Ventures said: “The cut in pension tax relief to £40,000 a year will increase the drive by many higher earners towards other tax efficient routes to build their retirement nest eggs. We have already seen a steep rise in enquiries from investors looking to supplement their pension pots through VCTs.”

Others expect the wealthy to divert their money from pension schemes into buy-to-let property, potentially driving up house prices even further.

It is high earners with final salary schemes, now largely confined to the public sector, who may be the surprise losers from the new caps on pension tax reliefs.

According to figures prepared by Hargreaves Lansdown, someone earning £55,000 a year could face a tax charge of as much as £13,000 in 2013-14 as a result of the pension cap, although they can take advantage of unused pension allowances to minimise the charge. The impact will be felt most by someone with a long service record who receives a pay rise towards the end of their career, which can have a significant impact on the final value of their pension.

Behind the potential tax bills is a complex calculation the Treasury uses to value pensions in final salary schemes. If the value of your expected annual final salary pension rises from £10,000-£11,000 a year, the Treasury says the extra £1,000 income is worth £16,000 in pension contributions, using a formula that multiplies the increase in income by 16. So, if over one year the expected value of a pension goes from £10,000-£13,000 it is assumed the person has received £48,000 in contributions, busting the new pension cap. In this instance, the individual will have to pay a tax charge of £3,200.

But in reality the cap will only really affect those people in final salary schemes who receive generous pay rises, for example from a promotion, rather than regular contributors. Hargreaves Lansdown estimates just 0.5% of its (relatively well off) customers will be hit as a result of the cap.

Matthew Phillips of advisers Broadstone Pensions & Investments warned that the changes to pension relief will damage saving. “By cutting the annual allowance the Chancellor will make no difference to the country’s finances. However, he has succeeded in sending out a completely mixed message on pension saving.” © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds

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