Fear of a cap on pension tax relief is worse for the inert

As the Budget looms ever closer, there are increasing concerns among contractors that the chancellor could be about to scrap higher rate tax relief on pension contributions, potentially limiting it to the basic rate of 20 per cent, writes IFA Tony Harris of Contractor Money.

During the election campaign that gave us the current, coalition government, Liberal Democrat policy was to remove the tax relief that higher earners receive to help fund increases in personal allowances, so the lower paid could fall out of the tax regime altogether.

George Osborne has resisted these calls to date, preferring instead to bring a cap of £50,000 a year to allowable pension contributions. But it seems that the plan to scrap higher rate relief has never fully gone away and could become a reality, as the Lib Dems increasingly seem to want to be seen flexing their muscles.

While an official decision has yet to be made, the very fact that Danny Alexander, Chief Secretary to the Treasury appears to back the plan suggest that cuts to relief may be on the horizon. As a result, we recommend that all higher rate taxpayers invest in their pension now, as previous changes that have been made to pension tax relief have only been applied to contributions made after the date of implementation and have not affected previous contributions.

When you invest personally into your pension, basic rate tax relief is in effect given immediately with the balance being claimed via your self-assessment tax return. These contributions will be limited to 100% of what may obviously be a low contractor’s salary. Company contributions are not linked to salary and are paid gross with the sum written off against your corporation tax bill while corporate pension contributions carry no benefit in kind.

Many contractors use their pension as a very effective means of transferring money from contract and into personal hands. This way, they can transfer up to 100% of their annual income directly into their nest egg using either company contributions, salary sacrifice or investing personally via their own bank account. Certain higher rate taxpayers could save the equivalent of 69% tax relief on contributions!

If the government does decide to scrap higher rate tax relief on pensions we would expect this to be done via a question on your self-assessment tax return, so that it will catch company contributions too. Although you would still be able to benefit from lower rate tax relief of 20%, clearly this could be a case of ‘buy now’ while higher rate relief is still available.

Wednesday 29th February 2012