This piece is in part a peace offering to Steve Lowe and Steve Groves, for my laying into the Just CETV kit, earlier this weekend (see above). I don’t buy the argument that two wrongs make a right, Just could go off and do something more useful than further destabilising people’s pensions.
But I side with Steve Groves’ point that the Pension Freedoms were poorly thought through and appallingly implemented. They have resulted in a spike in DB transfers which are best illustrated by the ONS.
This piece looks at one aspect of the “pension freedom” legislation (death benefits) and asks whether the surge is attributable to the tax treatment of transferred pension pots.
I conclude that this may be a powerful driver to transfer, (an aspect of our obsession with property ownership), but that it is no good reason to transfer (a delusion created by the wealth management industry).
Just may feel I am unfairly picking them out, (they are not the major villains of this piece), but I maintain that creating more disruption in the transfer market is not the way to put things right.
Are we getting so wealthy , we don’t need income in retirement?
After a rocky few weeks , where John Ralfe and I seemed to agree on nothing, I am happy to announce something about which we are as one. The implications of Bob Dyrbus’ letter to the FT
Is there a simpler explanation for the surge in transfers from final salary schemes — namely inheritance tax planning by the affluent? Much was made of the 50 per cent increase in the number of transfers rather than the almost 75 per cent increase in the average value of the transfer ( FT Weekend, May 19/20). In 2016, 61,000 people transferred on average almost £130,000. In 2017 92,000 people transferred around £226,000 each.
On admittedly a simple view that base transfers would have been the same in both years then in 2017 the additional 31,000 transferred out an average of around £416,000 or 220 per cent above the average 2016 transfer.
If one has other assets and income to live on the £416,000 is above the IHT threshold of £325,000 but on death is not taken into account for IHT and beneficiaries can draw it immediately.
I have sufficient assets and income from a defined benefit plan income. But my pension means that without planning my IHT liability would constantly increase. Had pension freedoms been in place when I started drawing my pension I would also have transferred my pension pot out.
London SW11, UK
John made his feelings plain on the implications of the 2014 tax changes, at the time (this letter is dated October 8th 2014
You have reported extensively on the chancellor’s announcement that any unused pension pots at death will no longer pay 55 per cent tax, but can be given to heirs and taxed at their marginal rate.
Rather than being a “punitive” tax, as often described, the current 55 per cent rate is neutral. It simply claws back tax relief already given to a 40 per cent taxpayer on the original pension contributions, and taxes investment returns in the pension pot and the 25 per cent tax free cash lump sum.
The new rules break the important principle that tax relief on pension contributions defers income tax but does not avoid it, since tax is paid on the pension income.
Income tax on pension contributions can now be avoided altogether by giving unused pensions at death to young grandchildren, who will pay no tax, if the annual amount is less than their personal tax allowance.
The likely total tax loss is huge. The latest official figures from 2010 show £370bn saved in personal pensions. If only 5 per cent of this is given to grandchildren who are not taxpayers, the loss to the taxpayer – versus paying 55 per cent tax – is over £10bn.
Clever accountants can stop looking for inheritance tax loopholes – the coalition government has created a simple way for the richest to avoid paying income tax and to pass on wealth tax free to their grandchildren.
This change has been spun as an incentive for people to save for their families. To ensure the wealthiest do not benefit disproportionally, the amount that can be given from an unused pension pot should be capped at, say, £50,000.
Anything above this should continue to pay 55 per cent tax.John Ralfe,
John Ralfe Consulting, Nottingham, UK
Paul Lewis, agrees with John, though in rather more strident tone!
So good that we spend £50bn a year in pension tax and NI relief to allow the rich to avoid IHT and pass a smalll fortune to their children. And I thought it was to encourage every one to save for their own retirement. Silly me.
— Paul Lewis (@paullewismoney) May 27, 2018
If Bob is right, and there’s a generation of cash rich pensioners who don’t need their pension, then this country is in much better financial shape than we might have thought.
But my guess is that for most people, having a wage for life in later years is more important than protecting grandchildren from IHT bills.
So is IHT planning driving the surge in pension transfers?
The letter is also an analysis of the rise in pension transfers from 2014 onwards and especially the 2017 spike. I am doubtful about the average transfers. The average transfers on which I have data show that the average transfer values taken in 2017 for schemes in the financial services sector were well over £500,000. On 40x multiples, you only need to have accrued a pension promise of £10,000 pa to have £400,000 in cash.
Most of the people I have met, who have “cashed in” their pension are ordinary people without IHT problems – who see £400k in hand as worth rather more than £10k for life.
The IHT planning that Bob Dyrbus talks of, refers to a peculiar phenomenon – relating I suspect to the London property market, where the next generation will have to buy back their parent’s house from HMRC, who will have a charge on the property unless the IHT bill is paid.
There is a peculiar affection among people of my generation to property ownership. The thought of the family home having to be sold to meet HMRC’s demands is noxious to the baby-boomer.
The traditional way of solving this problem was to take out a joint life second death whole of life insurance policy while both partners were still around and (in necessary) fund the premiums from the excess income from the private pension.
Turning this around and creating a trust fund from the pension is a peculiarly inefficient way of sorting the problem. It requires a lot of money to be paid to wealth managers and perversely, makes the job of financial planning a whole lot harder. The exchange certain income for the uncertainties of funds requires advice, something in short supply (and hence very expensive).
If I was advising Bob Dyrbus, I would – assuming he is in good health, be suggesting he uses his unwanted pension to put some capital on the shelf for when he is gone. Whole of Life policies can be put in trust, meaning it is only the premium (not the claim) that is taxable.
Of course my plan would not create so much work for advisers, but it has the merit of being simple and does not require the disruption of uprooting a mature pension tree!
It’s not wealth – but wealth managers – that’s the driving the surge in pension transfers!
The entire CETV surge can – in my opinion – be put down to effective marketing from the wealth management industry. They may have convinced themselves that middle England better profits from their managing its money than the defined benefit pension funds who expected to pay the pension.
They may have convinced themselves that IHT had best be mitigated by the management of capital rather than the employment of insurance.
They have convinced hundreds of thousands of us with DB plans that contingent fees are painless , hence the surge in contingent charging.
And they are obviously oblivious to the impact of the layered charges that choke capital growth on the wealth at source.
So all in all, the argument that transferring pensions into the self-invested personal pensions that give access to discretionary fund management, advised on by vertically integrated financial advisers, seems irrefutable.
And if you dare dispute the logic of the wealth manager- you risk the wrath of the entire wealth management empire – as I will undoubtedly find out, once they have read this piece.