Is the pensions revolution too good to be true?
From next April you will be free to take whatever income you want from your pension pot. This was the highlight of the pensions revolution chancellor George Osborne unleashed in his March Budget, along with interim measures to loosen the pension shackles.
This new-found freedom divides opinion. I'm broadly in favour of relaxing the restrictions on pension income and the way legacy pension pots are taxed. Treating people like adults and giving them full control over their own money has to be a good thing.
Along with the pension reforms, Osborne has raised the annual Isa limit to £15,000 from 1 July and announced a new range of 'market-leading' fixed-rate pensioner bonds from January. But I'd be surprised if there wasn't a sting in the tail to all this.
Reaching out to pensioners
With a view to next year's general election, the chancellor has very effectively cemented the Conservative Party's appeal to high earners, as well as reaching out to pensioners who have suffered from five years of negative real interest rates. But whichever party (or parties) ends up governing after May 2015, tax relief on pension contributions will be in their sights. It is the low-hanging fruit that any party with an eye on balancing the national accounts will see as ripe for picking.
It costs the Exchequer an estimated £30 billion-plus a year to subsidise our private pensions, and the lion's share of that subsidy goes to the people who can most afford to make large pension contributions: higher-rate taxpayers.
Tax Relief for Pension Saving in the UK, a paper by the Pensions Policy Institute (PPI) published in March 2013, makes the point bluntly: "Tax relief benefits higher earners disproportionately, with higher-earning employees receiving the majority of the tax relief from the government."
At that time pension allowances were higher than the £1.25 million annual allowance and £40,000 maximum annual contribution permitted in the current tax year.
Workplace pension auto-enrolment is expected to skew the share of tax relief received back towards basic rate taxpayers, but not by a meaningfully large amount – to 30% of the total tax relief pot.
Independent pensions expert Dr Ros Altmann makes the point that auto-enrolment may also pave the way for curbing tax-relief on pensions, given that a total 8% of salary will be salted away each year. Altmann asks: "I wonder whether, once workers are used to being automatically enrolled into pensions and once they better appreciate the value of an employer contribution, there would be a great attraction to the Treasury to reconsider pensions tax relief."
And what of the 25% tax-free lump sum that you can take from your pension before securing an income from it? The PPI reckons this costs the Exchequer a further £4 billion a year. It points out: "Under the current system, 77% of individuals have a lump sum of under £40,000, while only 24% of the tax [relief] on lump sums goes to these individuals."
It would be political suicide to retrospectively remove the tax-free lump sum pension incentive, but perhaps not so suicidal to draw a line in the sand, by limiting the lump sum amount that can be taken tax-free or reducing the tax-free proportion allowed on future savings.
It's highly unlikely that any political party would risk the wrath of the electorate by overthrowing the pension revolution before the general election. But the 2015 Autumn Statement could be the staging point for a counter-revolution focused on tax relief.
Meanwhile, there's the opportunity for some advantageous planning to maximise pension contributions. For higher-rate taxpayers, that could entail stuffing the pension pot up to the annual limit of £40,000 and also contributing any unused eligible allowances for the previous three tax years (when the limit was £50,000 a year).
But how to fund such a potentially large contribution? One idea is for equity-rich homeowners to take advantage of current low mortgage rates and a buoyant housing market to fund their pension contribution, with the loan being paid back from the tax-free lump sum. However, financial advice might be beneficial here, not least to keep on the right side of pension input period rules.
In his pension and Isa munificence the chancellor most definitely giveth, but he or his successor will most likely take away once the general election has been won.
This feature was written for our sister publication Money Observer
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
Payment protection insurance is designed to cover you should you fall ill, have an accident or lose your job and can’t make repayments on loans or credit cards. However, research by consumer watchdogs found the cover to be overpriced, filled with exclusions (policies exclude self-employment, contract employees and pre-existing medical conditions) and were often mis-sold because the exclusions were never fully explained. In May 2011, the High Court ruled banks had knowingly mis-sold PPI and ordered them to compensate around two million consumers.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.