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Chancellor Cuts Pension Tax Relief

Chancellor George Osborne reveals a cut to the annual tax-free allowance for pensions but raises the ISA contribution limit

Alanna Petroff 5 December, 2012 | 2:40PM

In his Autumn Statement, Chancellor George Osborne revealed the government's plans to restrict pension tax relief in the coming years.

Osborne announced a cut to the annual tax-free allowance on pension contributions from £50,000 to £40,000. He also announced plans to restrict the lifetime tax-free allowance for pension savings from £1.5 million to £1.25 million. These changes will go into effect starting in April 2014.

It is feared that this change to the annual tax-free allowance will deter people from saving for retirement, however, the change will only affect the small number of people who will have enough money to contribute more than £40,000 in a single year into their pension.

Meanwhile, in a move to encourage more people to save into their ISA accounts, Osborne announced plans to raise the ISA contribution limit to £11,520 in the 2013-2014 year. The current maximum that you can put into an ISA for the 2012-2013 tax year is £11,280

While the change to pension tax-relief may only affect a select few, commentators say the change is worrying.

“The number of people affected might be small, but there is a bigger issue here – if there are doubts over the future tax treatment of pensions, people at all income levels might be less willing to save into pensions vehicles," said Paul Sweeting, European head of strategy at JP Morgan Asset Management.

“However, retirement is about more than just pensions. Other tax-favoured vehicles such as ISAs have an important role to play in providing retirement income. It is important that individuals are aware of this, and plan for retirement using the full range of investment vehicles available,” said Sweeting.

In a recent Morningstar 'Perspectives' article, Tom Stevenson, investment director at Fidelity Worldwide Investment, explained that this change to the annual pension tax rules will affect the following kinds of people:

- People who were unable to contribute to their pensions during the expensive child-rearing years, who then want to contribute lump sums later in life.

- People who - through redundancy or inheritance, for example – want to contribute a lump sum into their pension. "It is surely wrong that the government should discriminate against people who wish to do the right thing in this way," said Stevenson. 

- High earners.

- Some public sector workers.

Below is an explanation from the Autumn Statement explaining the rationale for the pension cuts:

"In 2010-11, tax relief for pension savings cost the Government around £33 billion, with over half of this relief going to higher rate taxpayers. Even with changes made to reduce the cost of pensions tax relief, the Government is still likely to forgo around £31 billion in tax revenues this year, rising to £35 billion in 2015-16. To protect the public finances from this growing cost, from 2014-15, the Government will further reduce the lifetime allowance for pension contributions from £1.5 million to £1.25 million and further reduce the annual allowance from £50,000 to £40,000.

"These measures affect the wealthiest pension savers. 98% of individuals currently approaching retirement have a pension pot worth less than £1.25 million – the level of lifetime allowance that will apply from 2014-15 – while the median pension pot for individuals approaching retirement is £55,000. 99% of pension savers make annual contributions below £40,000 – the level of the annual allowance that will apply from 2014-15 – with the average person contributing around £6,000 a year."

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About Author Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.