A tale of two pensions

This blog is being written on Freedom Day – the date all residual Covid restrictions are removed (in England at least) and people can, in theory, go back to living their lives as though the virus never existed.

Whether this will happen is debatable. But it’s an opportune time to consider what the cost of Covid has been to the UK public purse, and how it’s going to be paid back.

One thing’s for sure: even when the pandemic is a distant memory, we’ll still be counting the financial cost.

The Government is expected to have borrowed more than £500 billion to support Covid spending by the end of this tax year, and that’s just the start – higher spending and reduced tax intake is likely to be a pattern for a number of years.

Paying for that is clearly going to take an above-average contribution from the taxpayer, and pension reform is one route the chancellor could take to try and recoup some of the money.

A potential double whammy could be on the cards.

Less in the private pot?

One of the anomalies Rishi Sunak could decide to address is the amount of tax relief given to higher earners on their personal pension contributions.

The Pensions Policy Institute found that those earning less than £50,000 made up 83% of all taxpayers, but they received only 25% of the tax relief paid out on defined contribution pensions.

If the chancellor decides to make the system fairer with flat-rate tax relief, it could be seen as an easy win in terms of public opinion.

Potentially more concerning is the rumour that he could reduce the lifetime allowance from the current £1,073,100 (frozen for the next 5 years) to around £800,000 or £900,000. If your pension pot exceeds the lifetime allowance, you will pay a charge of 25% on the excess if you take it as an income, or 55% if you take it as a lump sum.

It’s not only the super-rich who would be affected if this happens. Anyone in middle management in a public sector organisation who’s worked there for 40 years or so could easily be looking at a £1m-plus pension pot. (Indeed, generous public sector pensions have always been seen as compensation for lower salaries when compared to the private sector.)

Unlocking the triple lock?

Things are looking uncertain, too, for the future of the state pension, still the largest source of income for people over 65, according to 2018 research from The Just Group.

The so-called triple lock, invented by the coalition government in 2010 and one of the cornerstones of the Conservative manifesto ever since, could potentially net taxpayers a huge ‘pay rise’ next year.

The triple lock was brought in to address a long-term slide in the real value of pensions. It’s designed to ensure the state pension keeps pace by adjusting it annually by either the rate of inflation, the increase in the consumer price index or average annual wage growth, whichever is the higher.

Wages are currently rising at a rate of 7.3% (as of May 2021), although this is a ‘blip’, reflecting the fact that they were severely dented by the pandemic and actually fell by 1% in 2020-21. July is the month the government uses to determine annual wage growth, so it’s probable that the state pension will see a massive boost of around 8% next year – at a cost to the public purse of £3 – £4 billion.

This is likely to be further ammunition to those in parliament (reportedly including the chancellor himself) who believe that the triple lock rewards pensioners at the expense of the younger generation, who have been disproportionately affected by Covid lockdowns.

We’ll have to wait until next April’s budget to see what happens with the state pension, but there are steps you can take now to ensure your retirement plans aren’t battered by the Government’s need to shore up the public finances.

Accentuate the positive, mitigate the negative

The first thing to remember is not to let the tax tail wag the investment dog.

To paraphrase Benjamin Franklin, we can change everything except death and taxes. You can dampen some of their effects, but they’ll always be with us and shouldn’t define how you invest for your retirement.

Start with a pre-retirement check. Work out how much income you’ll need to have to finance your ideal lifestyle. Then work out how much extra you’ll need to save to get there. This is something that’s helpful to do every year, as any changes to tax and pension legislation could mean that strategic ‘tweaks’ are required.

Even if the lifetime allowance, annual allowance or tax relief rules do change, additional pension saving could be a good idea. Reducing your pension savings to avoid tax would be a bit like refusing a pay rise because you’d have to pay more tax.

Alternative tax efficient strategies could involve drawing down and recycling income efficiently or using Enterprise Investment Schemes, Venture Capital Trusts, Open Ended Investment Companies, Bonds or ISAs. All of these can add up to provide sources of capital and income when required, and allow you to manage personal taxation more effectively.

Finally, check if you can protect your lifetime allowance.

Caveat: None of the above should be taken as advice and you should seek personalised advice based on your own individual circumstances.

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