What’s the chancellor’s next move going to be with my pension?
Fiddling with pensions taxation could blight the retirement prospects of millions
http://www.ft.com/content/2e0f…
— Mark Locke (@langcatlocke.bsky.social) Aug 31, 2024 at 17:41
The impression this article of Claer’s gives is that pension saving is a tax-fiddle in favor of the wealthy at the expense of everyone else. Writing as she is for the wealthy, this reinforces my prejudice against the idea that
“the tax free cash is for most people the most valuable part of their pension”
In recent articles, I have given the impression that restricting tax-free cash to £268,175 as the Chancellor did when abolishing the LTA allowed the Treasury a thin end of a wedge which they could drive home with impunity.
But lately I have started hearing stories about people being denied “protected lump sums”, our administrators at Pension SuperHaven were going on about it the other day and I see that Steve Webb has had to devote his column to explaining why HMRC are stopping some people getting any more than 25% of their pension as a lump sum.
As I understand it, the 25% rule really arrived with personal pensions in 1988 (see the pension timeline). before that , tax-free cash was calculated as a percentage of the pension you were giving up , not the pot. Typically this was around 33% of the pot , a more generous offer – assuming you valued cash in your bank account over an insurance against the financial consequences of living too long.
This formula lives on when calculating tax-free cash from defined benefit schemes where there is no pot – only pension. When you transfer away from a defined benefit scheme , you lose the use of the formula. If you have a very old style pension known as a retirement annuity contract or S226 pension , you can take cash up to three times the initial annuity, and if you have a guaranteed annuity rate you will probably be looking to use this formula ( a hangover from when money purchase pensions were a variant of DB pensions).
Poor old Steve Webb has been charged with explaining all this in a couple of hundred words, to readers of his Daily Mail column
My latest for This is Money: people with protected tax free cash etc on hold until HMRC fixes defective pensions legislation which was rushed through before the Election: http://www.thisismoney.co.uk/money/pensio…
— Steve Webb (@stevewebb1.bsky.social) Aug 26, 2024 at 9:13
Apparently the abolition of the Lifetime Allowance (in a practical sense) has not been a complete break with the past. Vestiges of it live on – it is used to calculate the £268,175 max tax free cash and it is complicating the payment of these higher (protected) tax-free cash amounts.
Here’s Steve’s explanation
.. for 2023/24, the LTA was retained but the penalty tax charge on those who exceeded it was set to zero. In 2024/25 the LTA was abolished altogether.
Unfortunately, abolishing a limit like this is not quite as simple as it sounds.
There were literally hundreds of references to the LTA scattered across different pieces of legislation and HMRC had to consult on exactly how to remove the LTA without having unintended consequences.
They also needed to work out how to design and implement a brand-new lifetime limit on tax-free lump sums.
Many experts within government and in the pensions industry warned that this was being rushed and the work could not be completed by April 2024, but the political timetable of an upcoming election meant that these warnings were ignored.
What has happened as a result is that HMRC have admitted that they still haven’t got all the necessary legislation in place for the new system to work properly.
One group of people affected are those such as you who have ‘protections’ which make your pension position particularly advantaged.
This kind of preservation of ancient rights is known in legal circles as “grandfathering”. There are other grandfathered rights clogging up pension administration which collectively cost more to administer than they protect but individually are matters of life and death.
If we didn’t have an army of pension lawyers, most of this stuff would be swept away, but we do have such an army and so we have to preserve the rights to tax-free to all who have grandfathered benefits , Steve has to write these tedious things and we tut-tut about the complexity of pensions.
But I’ll finish by challenging the primacy of the tax-free cash as the nation’s favorite pension benefit. It is because it is easy to calculate (we can divide by four) and because once banked, tax-free cash is out of the reach of the tax-man.
Except it isn’t really, because when we spend it we pay VAT and if we invest it , it becomes subject to income and capital taxes. Weirdly, if you avoid taking the cash, it rolls up in your pension pot tax-free and comes to you later.
Deferring gratification is generally seen as a good thing by the tax-man , which is why growth on pension pots is tax-free. But if the tax-free cash entitlement comes under threat, as it is right now, then a lot of smart people will forestall anticipated “pain”, by taking the cash before its natural time.
Except it isn’t always that easy. Because people like Steve Webb’s questioner, aren’t actually getting their tax-free cash. It is stuck in the pipeline and that’s causing some people palpitations as they anticipate they could be capped by changes in the budget while awaiting resolution of this technical issue around the LTA.
A lesson to be learned
All of this nonsense complexity is about tax, it is not about pensions. Pensions are an insurance against the financial consequence of living too long, they are not a tax-dodge for the wealthy.
By appropriating pension wrappers as part of the tax-advisory world of high net worth financial management, IFAs have repurposed pensions as a means of sheltering wealth.
And in this, they are capturing pensions for what I can only describe as “selfish” purposes. Rather than being collective vehicles designed to relieve poverty, they and HMRC have driven pensions into a bad place where Claer Barrett can describe the pension system as “Jenga”, a structure which should one tax rule change, the stack comes falling down.
HMT needs to restore pensions to their original purpose and target tax-relief not at wealth preservation but as an insurance against us living too long.
The Pension Timeline – The history of pensions _ Pension Access
Britain won’t rejoin the EU for decades — if ever
FT today there are bigger issues to be concerned about
“I have given the impression that restricting tax-free cash to £268,175* as the Chancellor did when abolishing the LTA”
Contrary to your statement, prior to the abolition of the LTA if you wanted tax-free cash (PCLS) you were limited to 25% of the remaining LTA. So someone on the standard LTA who had not previously drawn a pension would also have a limit of £268,275 [sic] for the PCLS.
*Pardon the pedantry as well but the standard LSA is £268,275
How come most commentators seem to believe that Labour will be raiding their personal pension piggy bank whilst forgetting that’s what the Conservatives did for 14 years?
Yes, Labour introduced the LTA but it was the Tories who massively lowered it resulting in less tax free cash. It was the Tories who decided to freeze the personal allowance so that more pensioners start having to pay tax, or more middle earners start to pay 40% tax.
There is always uncertainty around what will be in the budget but it seems to me that the press and public will credit a Tory chancellor with prudence for charging tax (“Well they had to because of Covid”, “They had to because of the global recession”) but view a Labour chancellor’s actions differently (“They always raise tax”, “They always spend from a magic money tree”).
I’m not making a political judgement on what has been or will be done, just commenting on the reactions to the past and scaremongering of the future.
“ I’m not making a political judgement…”
LOL