Government proposes annual allowance of £40,000

The coalition government is proposing to implement an annual allowance for pension contributions of £40,000 as alternative to Labour’s policy of restricting tax relief on pensions for higher earners.

In its report Restrictions of pensions tax relief: a discussion document on the alternative approach the government said it envisaged that the allowance would be set at a flat rate and would not vary by age or by scheme type.

The document, which is part of an informal consultation, also suggests capping tax relief at 40%. This would further reduce the amount of tax relief available to additional rate 50% taxpayers and therefore raise more revenue.

Cutting the lifetime allowance from £1.8 million to £1.5million is also on the cards – a change the government has indicated might result in indexing the annual allowance over the longer term. 

The National Association of Pension Funds (NAPF) said the proposals were a step in the right direction and will be less damaging to workplace pensions that the previous government’s plans to restrict pensions tax relief.

Joanne Segars, chief Executive of the NAPF, said: “Setting the annual allowance at £40,000, as the paper discusses, could be workable, but much depends on other variables that are yet to be confirmed.

“The provisional view in favour of ‘flat factors’ for valuing defined benefit contributions is welcome, as it is important to keep the system as simple as possible. Much will hinge on the level at which the valuation factor is fixed.

“But it is disappointing that the government seems to be pressing ahead with including past service in the valuation of defined benefit pension rights. At a stroke, this will drag many people on modest earnings with ‘final salary’ pensions into the net.

Mark Jackson, partner at Lane Clark and Peacock, added: “The further detail in the discussion document will satisfy employers for a short time, but it is disappointing to learn that confirmation that the annual allowance is the way forward will not now be until the end of September.

“The Treasury document recognises employers have a great deal to do to manage the impact of the tax changes, but bearing in mind that changes to pension schemes normally need at least three months’ consultation with affected parties, plus planning beforehand, the window to April 2011 is getting very small.”

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