Dodge Osborne’s pensions raid on your savings

Popular opinion is that George Osborne, the chancellor, has it in for low earners. But look at his actions and you could be forgiven for thinking that he really has it in for high earners. A few weeks ago, I devoted the editor's letter to listing all the new taxes that those earning £100,000-a-year-plus have been subjected to over the last few years. It isn't a pretty picture.

But the biggest attack on the tax regime for "the rich" so far is that on pensions tax relief. Look at the numbers on this and it looks as though it makes sense for the tax relief offered to higher earners to be cut. In 2014/15, total pension tax relief came to £34.3bn, with some 59% of that going to those earning over £45,000 a year.

But I'm not entirely convinced that it does make sense. Being a high earner is usually a temporary state of affairs. Very few people start off on salaries of £45,000 and stay there for a whole career. They start much lower and work their way up spending a few years as higher rate (or in the best cases, additional rate) payers at the peak of their careers. These years will also be the years in which they contribute most to their pensions.

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Look at it like that and it seems entirely reasonable to me that the majority of pension tax relief goes to higher-rate taxpayers. Sadly, it doesn't appear to seem reasonable to the government which rarely takes the transitory nature of high-ish salaries into account so change is coming.

The first thing to worry about is the new limit for the lifetime allowance (LTA), the total amount you are allowed to keep in your pension fund. We've looked at this ridiculous cap in the past (read James Ferguson's piece on it from last year), but it is being reduced (again!) from £1.25m to £1m from April 2016. Any savings you have in your fund over this limit on retirement will be taxed at a punitive 55% rate on withdrawal.

The second is the new tapered annual allowance, aimed at those paying higher-rate taxes. From April next year, if you have earnings in excess of £150,000 (including all your dividend payments and income from property, as well as your PAYE salary), you will start to see your £40,000 annual pension allowance tapered. For every £2 of income you earn, your allowance will fall by £1. The result? By the time you hit £210,000, your annual allowance will be down to £10,000, where it will stay. That's an effective cut in tax relief of £13,500 (45% of £30,000). It also doesn't leave much.

We accept that putting £10,000 a year into a pension might be beyond the wildest dreams of much of the population. But remember that most people don't start saving seriously until they are in their 40s. Assume that they save for a mere 20 years and that it compounds at 5% a year. At that rate, you end up with a pot of £340,000 enough to provide an income of about £11,000. Not exactly Lamborghini territory, is it?

Most people aren't much bothered about this change only 364,000 people in the UK earn over £150,000 a year in salary. And who cares about 364,000 rich people? However, it isn't just about them it's actually about many, many more. Why? Partly because the 364,000 only refers to PAYE salaries. Many more make the £150,000 cut via freelance income, dividend income and rents, and the new rules very specifically include all of these in the income allowance for pension purposes. But it also matters because, as I point out above, incomes aren't static.

Those on £150,000 work their way up in just the same way as those on £45,000. So while at any one time there are 364,000 high earners, over a ten-year period there could be a couple of million (although I can't get solid data on this). But here is the key point: these high-earning years are the ones during which people really feel able to add to their pensions and lock in a secure old age. Unfortunately, they're also about to become the years in which they can't.Still, all is not lost. There are several things you can do if you move fast to soften the blow.

1. If your fund is close to the old LTA, consider putting as much money in as you can now and then apply for "individual protection 2016". This allows you to keep the old allowance of £1.25m. However, you might want to check with your employer first: they might switch their employee's contributions to your pension into salary instead. If they won't, it may be worth going without protection and paying the 55% later in order to keep getting their contributions: 45% of something being better than nothing.

2. If you earn £150,000-plus, or think you soon will, look behind every sofa cushion you have and pile the pennies into your pension (subject to the LTA, of course).If you didn't use your full allowances from last year and the year before, you can, under the carry-forward rules, use them this year. That's a possible £100,000 (the allowance was £50,000 until April 2014). You can add to that this year's allowance (£40,000) plus a possible extra £40,000. As part of a "tidying up" of some rules known as pension input periods (or Pips), the government effectively reset the pension allowance on 9 July. So even if you contributed your full £40,000 in advance of that date, you can still put in another £40,000.

If you can, you should even if it means sacrificing salary or bonus. Note, however, that the amount you can put in a pension in any one year is, regardless of allowances, capped at how much you earned that year: so you can only put in £180,000 if you earned £180,000. You should also have a word with your employer: if their contributions take your total contributions over your new limit you will need to ask them to shift some of it to salary.

3. If your income is variable, talk to an adviser. If you are self employed or a partner in a firm, this is going to be tricky. Why? Because you often won't know what your income is until very near (or often after) the end of the tax year. You might need help it is irritating but as is often the case one of the main beneficiaries of the new rules will be accountants.

4. Start thinking about redistributing income and pensions contributions within the family. If you pass ownership of all income-earning assets to alower-earning spouse you might be able get your own income down enough to keep a better chunk of your own allowance. Failing that, as everyone earning under £150,000 will (as things stand) keep their £40,000 allowance, it makes sense for the high earner in a couple to contribute to the pension of a lower earner (this stuff is all fairly shared out in divorces these days, so no worries there). This isn't quite as brilliant as contributing to your own, in that the amount you can put in is capped at £3,600 or the amount that your partner actually earns over a year. At the same time, the tax can only be claimed back at his/her marginal rate. Still, 20% tax back is better than nothing.

5. If you are a 40% taxpayer, put whatyou can into your pension too.The government has been conductinga review of pensions taxation and has said it will come to a conclusion next year. However, all the hints suggest that there will be cuts to tax relief. This might come in the form of a reduction in the level of the tax-free lump sum we can all take (currently 25% of our fund), but it looks likely that it will end up being a shift from offering tax relief at marginal rates to offering a flat rate relief at something like 30% for everyone a shift that would mean low-rate taxpayers get free money (more "relief" than they actually would have paid in tax) and higher-rate payers pick up the tab.

Note that if you get 30% back on a pension now, but are still a higher-rate taxpayer at 40% on your retirement, this early tax relief isn't really much of a deal. Given this, it makes sense for all those who are or who expect to be 40% taxpayers to put as much as they can into their pensions now 40% being better than 30%.

6. Think about your 25% tax-free lump sum. There is a chance that the government's review will result in a cut to the lump sum that everyone can withdraw from their pension tax-free on retirement. It could be a percentage cut (say from 25% to 15%) or it could be a cap (perhaps no one will get more than, say, £50,000 tax-free). With that in mind, if you are of retirement age but have not yet started to draw on your pension, there is an argument for doing so and taking the 25% sharpish. You might want to take advice on this.

The buy-to-let Ponzi scheme

If you can't put any more money into a pension, then how do you save for your old age? This is a tricky one. The obvious answer for many is to buy a buy-to-let property and hope that it ends up offering you a capital gain and an income in your old age. This is a popular option: some 80% of the mortgages offered over the last year have been to landlords, and Office for National Statistics' figures show that, while savers know that workplace pensions are safer than property, they are also convinced that property produces "better returns".

But this is far from a given. New tax rules have been introduced that make borrowing money to get into buy-to-let significantly less attractive than it was (you will no longer be able to write off the interest on the mortgage against your taxes at your marginal rate see James Ferguson's article from Septemberfor more on this). And the market also comes with a high level of risk. Note that earlier this week the deputy governor of the Bank of England, Sir Jon Cunliffe, said that rising interest rates (it has to happen one day!) "could cause a substantial number of buy-to-let landlords to seek to exit the market, put material downward pressure on house prices and amplify an adverse shock to the housing market".

Others don't use such measured language. Writing in The Times, Philip Aldrick points to the huge level of debt propping up the property market. In the 1960s, real estate accounted for 35% of bank lending in advanced economies. Today that number is almost 80%. The property market, says Aldrick, "is turning into a Ponzi scheme that Madoff could only dream of." And the golden rule of Ponzi schemes? They cannot last forever.

Look at it like that, and property might not be the best place to stash cash you are going to need in ten years. It might be better to check you are using all the allowances that you have elsewhere to the full. One key thing is to be sure that you are using all the tax-free allowances available to you at the moment. The key attraction of pensions is that the cash you put into them goes in tax-free.

However, it is worth remembering that you pay tax on the cash as you take it out. Individual savings accounts (Isas) work the other way around. You put taxed money in but once it is in, that's that any income you take from them comes tax-free. The first thing to do is to make sure you are using your Isa allowance to the full. A couple can currently put in £30,000 a year between them. Do that every year for 20 years, and compound it at 5% a year in real (post-inflation) terms, and you'll have around £1m, enough to take out a 100% tax-free income of £35,000 or so a year before you even start on the capital.

Next, remember that ordinary investment accounts outsideIsas and pensions are a pretty good deal too. Buy a collective fund and the returns within it roll up tax-free (bar the part that is paid out to you as income). If you then don't sell until you are retired, you can take £11,100 out of your portfolio every year inside your capital gains tax (CGT) allowance. You can also receive £5,000 of dividend income without paying any tax at all. So that's another £16,000 of tax-free cash.

There's more. Higher-rate taxpayers are to now get a £500 tax-free allowance on interest from savings (base-rate payers get £1,000). So there you have it using these figures, a tax-free income of more than £67,000 a year is entirely possible before you even start on your pensions income.Finally, if you are still tempted to get a buy-to-let instead, then here's an interesting comparison for you (courtesy of Hargreaves Lansdown): over the last ten years the average balanced managed pension fund has returned 60%, whereasthe average UK property price is up only 24.2%.

Final salary schemes aren't safe either

Most of the commentary on the new pension rules is aimed at those of us with defined-contribution (DC) schemes. But they will have a huge effect on those in defined-benefit (DB) schemes (the ones where you get a percentage of your salary as an annual income on retirement) too. The value of a DB pension for tax purposes is worked out as being 20 times its annual value, plus the automatic tax-free entitlement. In practice this works out at about 23 times the pension income, says Patrick Collinson in The Guardian.

That means that if you are expecting a pension of anything over around £43,000 a year (which many doctors, university employees and public-sector workers are), you couldbe in breach of the new £1m LTA. PFM Dental, a medical financial services specialist, gave Collinson the example of a doctor who is to draw an annual £50,000 NHS pension, but also has a £250,000 personal pension saved up. The combined value (the £250,000 plus the LTA valuation of the NHS pension) would produce an excess over and above the LTA of £350,000 and an annual tax bill of £4,375, which would then be taken off the pension payment every year. As is the case with DC pensions, this is something that could be partially mitigated by applying for protection and again, this might require advice.

Want to retire in style? Work for the EU

The European Union's total pension liabilities rose by £8.6bn last year, compared with 2013. This is partlya result of low interest rates (whichpush the technical cost of long-term liabilities up), but it nonetheless brings the current long-term cost of the system for the UK to £5bn.Why so much? Simple, says The Times. In most places, civil servants are being gradually forced to pay more into their pensions and toreceive less when they retire. Not so in the EU.

There, theyare on average contributing less and receiving more. The proportion who are retiring on "elsewhere unheard-of schemes", which pay out 70% of final salaries, has actually risen by 4%. Note that MEPs make no contributions at all to their pensions, but still get an annual pension of £13,760 for each five-year period they serve. If you or I wanted to buy that £13,760 pension (which, I remind you, they get after five years) as an annuity on the open market, it would cost us around £500,000. Nice work if you can get it.