With flat rate tax relief back on the agenda more complexity awaits
It’s probably over two years since the subject of flat rate tax relief on pension contributions seriously reared its head, but the Treasury Select Committee has put the topic very much back on the agenda in its report on Household Finances, published on 26 July 2018.
A change to tax relief is portrayed as a means of incentivising the majority to save for retirement, rather than just higher and additional rate taxpayers. With 52% of all relief paid going to individuals earning over £50,000 it is difficult to challenge the thinking behind a fairer distribution. Auto-enrolment has exceeded original estimates with an additional 9 million people as at the end of 2017 saving towards retirement, and offering the lower paid an upfront enhanced payment to their contributions can only add to its success.
Will such a change be sustainable and straightforward?
According to The Resolution Foundation, the introduction of a flat rate at 25% would raise a further £4bn a year for the Treasury. At a time when the Government is clearly looking for ways to increase revenue this helps justify such a radical change. It has also been suggested that the annual allowance be reduced, which would also raise further income for the Treasury.
If a flat rate of 25% relief was presented to Joe Public in the form that for every £3 he saved from his income (up to a certain amount each year), the Government would give him an additional £1 then it would appear simple, and job done. However, how would it actually be administered in regards to employer contributions? For defined contribution schemes it will be complex but for defined benefit schemes it could be a nightmare.
Now consider instances where employer contributions are only entitled to relief at 25%. Currently employer contributions paid gross under net pay arrangements effectively receive immediate relief at the employees marginal rate. However, if this had to move to a relief at source model in order to deal with the introduction of a flat rate scheme, it gets complicated rather quickly. One potential solution would be that instead of making a gross contribution of £4, the employer would make a net contribution of £3, with the pension provider claiming back the £1. The employer would then have to put the gross £4 contribution through their payroll system to ensure the grossed up contribution is taxed at the employee’s correct tax rate.
If you thought that was complex, how about defined benefit schemes? The employer contribution could be based not on the actual amount paid in on behalf of the employee but on the value of the benefit accrued. It is presumed that this would be calculated along similar lines to how we currently calculate the pension input amount for annual allowance purposes, but with an adjustment made to take account of any employee contributions. This would have to be done for every active member and at the very least at the end of each tax year. This could prove very cumbersome and may take some time to implement.
Lastly, there is the potential political backlash, primarily from those in the public sector and NHS, as the true value of their accruing pension rights becomes apparent due to the increased tax that they may have to pay. At a time when there is an easing of pay restraints in the public sector this could be construed very much as a case of robbing Peter to pay Paul.
We will have to wait until the Budget to see if there is any movement on this, if there is, the practicalities of delivery are likely to cause headaches for scheme administrators.
For advisers, with the rumoured flat rate tax relief back on the radar, it is perhaps justified in raising the subject with clients who are in a position to make further contributions before the Budget. If clients hold off until then, there is the possibility that anti-forestalling legislation could be introduced and the ability to receive tax relief at a client’s marginal rate could be lost on those delayed contributions.
This blog first appeared on Professional Adviser