Pensions tax relief is to be sharply reduced under new government proposals, but the reduction is not as great as feared.

From April 2011, the tax-free annual allowance will be reduced from £255,000 to £50,000. The Treasury said this would affect 100,000 pension savers, of which 80 per cent will have incomes over £100,000.

The Treasury consultation suggested that an allowance of between £30,000 and £45,000 a year could be implemented.

The lifetime allowance – the limit of a pension’s total value before it is taxed – will decrease from £1.8million to £1.5million, from April 2012.

Financial secretary to the Treasury, Mark Hoban, said: “We have abandoned the previous government’s complex proposals and developed a solution that will help to tackle the deficit but not hit those on low and moderate incomes. We have taken a tough but fair decision.”

The measures will raise £4billion for the government, while setting the allowance at £50,000 a year will protect those on low and moderate incomes from being affected.

To protect individuals who see large one-off accruals in a pension scheme, people will be able to offset large amounts against unused allowance from previous years.

Measures broadly welcomed

Andrew Tully, senior pensions policy manager at Standard Life said he welcome the move.

“The allowance of £50,000 allows the vast majority of people to save as much as they want, when they want. This change means pensions will continue to be an attractive home for long-term savings, retaining the unique advantage of an upfront tax incentive from the government.”

Pensions strategy director at Legal & General, Adrian Boulding, said the simpler system of tax on long term savings would preserve incentives for saving, but said the government should consider linking the annual allowance to the earnings inflation index.

Joanne Segars, of the National Association of Pension Funds, said the announcement signaled a ‘pragmatic approach’ and said it was important changes to taxation remained focused on higher earners.

Pensions development manager at AEGON, Kate Smith, said the rule allowing unused annual allowance would be useful for people selling a business or wanting to invest redundancy money into their pension while avoiding a large tax charge.

Define benefit schemes

Tully, at Standard Life, said that people on defined benefit schemes could be affected by the allowance change, especially if their salary increased.

“The new valuation factor for people with benefits in defined benefit schemes is reasonable and reflects the valuable benefits being built up. The new system allows people to carry forward any unused annual allowance from the previous three tax years, smooth out large pay rises and there are special rules covering ill-health, early retirement and death.”

He said these concessions would make it unlikely that any basic rate taxpayer would be affected.

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