Budget 2012: Pensioners pay for tax cuts for the rich

George Osborne’s ‘granny tax’ in the form of the abolition of the Age Related Allowance (ARA) has created uproar among older Britons.

He announced that the ARA will be phased out from next year with anyone born after 5th April 1948 only qualifying for the standard personal allowance. Anyone already in receipt of the ARA will still get it, however it will be frozen and so will eventually be overtaken by the standard personal allowance.

“For many older people the abolition of the age-related allowance for over 65s, and the freeze on tax allowances, will be seen as a tax by stealth on their already stretched finances,” said Dr Ros Altmann, director General of Saga.

The actual impact for many households will be relatively low – an average of £83, however the symbolic damage to the Government of being seen to raid pensioners’ allowances to pay for a cut in the top rate of income tax might do considerable political damage.

The cut in income tax rates for higher earners to 45% could also have an impact on retirement savings. Because it has been delayed until 2013, I imagine we will see some wealthy individuals deliberately deferring income until they can get away with only paying 45% tax rather than 50%. In the meantime, there is an obvious incentive for them to make pension contributions before April 2013 as they will get tax relief at 50% rather than 45%.

[Related link: Open a self-invested personal pension]

Not all bad news for pensioners

There was a welcome silence from the Government on pension tax breaks. This was in spite of calls from the Liberal Democrats and others in recent weeks who have advocated reducing the amount of tax relief granted to higher earners.

This may be justified in principle, however any attempt to cut the tax relief would have been fiendishly complicated and would have sent a very damaging message about the Government’s willingness to treat pensions as an ATM.

The announcement of reform of the state pension is also very welcome news. Instead of a complicated system of Basic State Pension, State Second Pension and a bureaucratic architecture of means testing around the Pension Credit, in the future we will have a single universal state pension of around £150 a week.

This will still be based on National Insurance contribution history so there is no question of immigrants just turning up at Dover and claiming a full state pension. It will be redistributive, meaning that higher earners will get lower state pensions than they might have done under the old (present) system however I think most people will accept the new rules for the simplicity they bring.

They will certainly make it easier for today’s workers to plan their retirement, knowing how much they get from the state and being able to target their private savings to deliver an income on top.

Public sector pension pain

The reform of the state pension is also going to cause problems for public sector workers as it will mean the end of contracting out. This will necessitate an increase in their National Insurance rates of 1.4%; I can’t see that going down well.

The Government also announced that the state pension age will be linked to longevity in the future. We already know that the state pension age will rise to 67 by 2028; further rises now look inevitable for the years ahead.

This may cause some problems for pensions such as final salary schemes, which are based on delivering benefits in line with the state pension age. Similarly, targeting defined contribution pension savings will get more complicated if the target retirement date is moving.

I suspect that the only answer to this will be to engage more in retirement planning right through our working lives.

[Related link: More from Hargreaves Lansdown]