Govt plans cutting tax relief on pension compensation

The Treasury has proposed to remove tax relief on compensation payments for pension mis-selling.

However, it warned the move may lead to increased costs for both pension investors and providers.

In a consultation on abolishing 36 tax reliefs, launched on 27 May, the Treasury revealed plans to remove the exemption from capital gains and income tax on compensation from pensions mis-sold between 1988 and 1994.

Around a million people were mis-sold personal pensions in the late 1980s, when occupational pensions were likely to be more suitable.

Although tens of thousands of people have already received compensation, it is not known how many have yet to make a claim.

The government said the relief on compensation will not be required once all the relevant compensation payments have been made.

It pledged not to remove the reliefs until "suitable transitional arrangements" to minimize the impact were in place.

The Treasury aims to set a deadline by which outstanding cases must be settled and compensation paid, after which tax will be levied on compensation payments.

This period, the government anticipates, will be around five years from the passing of the Finance Bill 2012.

However, the proposals include a warning the removal of reliefs may cause complications for investors, as compensation payments into their pension pots may be hit by the new annual and lifetime allowances.

Gareth James, technical marketing manager at AJ Bell, said compensation payments directly into pension pots should not be taken into account when calculating annual or lifetime allowances.

"Compensation in relation to pension mis-selling is about putting the pensions of individuals back into the position they had reached based on pension accrual made many years ago, well before the annual allowance had been created," James said.

"To say compensation payments which end up in the pension scheme should now be tested against the annual allowance does not make sense.

"If compensation payments are treated as relievable pension contributions this also causes the loss of enhanced protection, so even a small amount of compensation paid to a pension scheme could have a negative impact on the tax position of some pension schemes."

However, John Lawson, head of pension policy at Standard Life, said the majority of people mis-sold pensions in the 1980s will have made their claims already.

"These claims will have reduced to a trickle and will be even fewer in 2017 at the end of the transitional period, so the admin burden will not be large.

"We may end up with complex admin for the cases that will still arise after 2017, but the number of new cases will be so small as to be insignificant."