The worst financial hangover

December’s pre-Budget report announced measures to try to stave off the worst effects of the financial crisis.

The Government had already warned those with the widest shoulders would carry the burden of helping the UK back into the black. Following the dangerous precedent set in April’s Budget when the link between income tax rates and pensions tax relief was severed, pensions were an easy target. But with a surprise extension to the pensions reform timetable, as well as the feared further unravelling of pensions tax simplification, the Chancellor managed to hit both high and low earners.

April’s Budget announced higher rate tax relief on pension contributions would be restricted, from 6 April 2011, for people with a gross income of £150,000 or more. A move many commentators feared would be the thin end of the wedge. Once the long-standing pensions deal was broken the temptation to further erode long-term tax incentives for short-term gain could be too strong – and so it has proved.

The pre-Budget report considerably widens the net, adding between 70,000 and 85,000 to the number of people caught by both the permanent changes to pensions tax relief after April 2011 and the temporary anti-forestalling legislation already in place. People with a gross income of £130,000 or more will now have to include the value of employer pension contributions in the definition of income. If this pushes them above the £150,000 threshold they will be affected. The special annual allowance threshold, introduced by the anti-forestalling rules, will also be reduced to £130,000 from 9 December 2009. There’s protection for pensions savings made from 22 April 2009 to 8 December 2009 for people newly caught by the rules.

Employers will need help to identify which employees are affected by these changes. For defined contribution schemes it will be relatively straightforward to work out the value of employer pension contributions but it’s likely to be a bigger issue for defined benefit schemes. The Government is consulting on how benefits will be valued for this purpose.

At the other end of the spectrum there was a surprise announcement to increase the staging in of employers’ automatic enrolment responsibilities from three to four years. When combined with the phasing in of contributions it means the full contribution of 8% of band earnings will not start until October 2017. While saving the Government an estimated £2.4 billion in tax relief between 2012 and 2018, it goes against one of the key aims of the pension reform agenda – to get people saving for their retirement. We all know the key to a decent retirement income is to save as much as you can as early as you can.

This move unfairly penalises the majority, who work for the larger employers, by making them wait until the minority are ready to begin saving. The Government can give people who can afford to save a head start by encouraging them to make pension contributions as soon as possible. They can do this by introducing early voluntary automatic enrolment to GPPs ahead of 2012 and by developing a clear communications programme showing it pays to save.

Rachel Vahey is head of pensions development at AEGON Scottish Equitable