TAX NEWS - June 2010

UK Tax: Tax relief on contractor pensions looks under threat

As the new coalition government struggles to find ways to reduce the budget deficit, George Osborne, the chancellor, is consulting with the pensions minister Steve Webb to weigh up potential options for cutting the huge cost of tax relief on pension contributions, writes Tony Harris, of independent financial advisors ContractorMoney.

It seems increasingly likely that some form of further restriction on higher rate tax relief will come into force in the emergency budget on 22nd June. This grim prospect for individuals earning more than £100,000 is made all the more likely by suggestions in the Lib Dem manifesto that relief for such wealthy investors should be axed outright.

So is there anything contractors can do to potentially avoid the impact of any further restrictions on their ability to save for retirement?

Since pensions simplification came into force in 2006, thousands of contractors have joined the increasing numbers of taxpayers who use pension investment as a very effective tax planning tool. However with the tax saving now running into many billions of pounds of lost revenue for HM Revenue & Customs, last year saw the introduction of two separate restrictions on what had hitherto been almost unlimited scope for freelance contractors to invest.

Higher earning consultants, those with an income of more than £130,000, fell victim to moves by the then-chancellor Alastair Darling to curb higher rate tax relief to a maximum £20,000 per year into a pension. Crucially this clampdown only applied to new investors, whereas contractors who had invested regularly prior to the changes were left unscathed. For these savvy investors, the pensions cap only applies if they make contributions over and above the level that they were investing at before the changes were announced.

In light of this precedent, contractors who may be considering pension investment could be better off starting to contribute ahead of the emergency budget, because last year's restrictions did not apply to plans that had been set in motion prior to the pre-Budget report on December 9th 2009.

On a more positive note, the coalition government also looks set to use next week's emergency budget to firm up plans to abolish the current requirement to use pension funds to buy an annuity at the age of 75. If realised, this move will help contractors retain more investment freedom and potentially allow a greater sum to pass to your family on your eventual death. Currently annuity providers can greatly benefit, financially at least, from the early death of a retiree. However by delaying buying this rigid income you may be able to benefit from extra ongoing investment growth with a potentially larger associated income stream, while also potentially passing more of your hard-earned cash onto the next generation.