Why we should slash the cash and pension the pot!

henry tapper

2 years ago

This would be the quickest way to destroy confidence in pension saving … https://t.co/4CMFYUDySF

— John Ralfe (@JohnRalfe1) October 9, 2024

In the context of the past 25 years pension policy, John Ralfe is right. A very large number of people see their pension as a capital reservoir not a retirement income. These are people who use pension’s income drawdown freedoms, do self-assessed tax returns and worry about tax- A LOT.

These are people who have DB pensions of more than £20,000 pa or DC pots of more than £400,000 who have benefited from higher rate tax-relief, salary sacrifice and tax-free investment growth on their pension saving and/or accrual.

For these people, the capping of tax free cash at £100,000 will mean they will pay more tax on the spending of their pot and more tax in converting their DB pension to a tax-free sum.

It is fair to say that for these privilidged people, the taxing of their pension lump sum above £100,000 of drawdown will probably be at a high marginal rate and could reduce the benefit in hand by as much as 45%.

Because of the impact of forestalling, the Chancellor is unlikely to give savers a period of grace to get their tax-free cash out (people who want to have done that have probably missed their chance if they have not started the process by now (my PCLS took 5 weeks to process).

So you might liken the implementation of the “under-consideration” slash to the cash as the pensions equivalent of VAT on school fees, it will deter the wealthy from saving but is unavoidable for those who have done their saving and are now pension wealthy. The analogy is with parents who cannot unwind the educational plans in place, but find the subsidies on school fees reduced.

The other way of looking at it – turning pots to pensions

The last 25 years has taught us to consider pensions as tax-incentivised saving not insurance against impecunity in later life.

The Government is belatedly trying to turn back this conception of “pensions” though it is still at an early stage of understanding the difference between a pot and a pension

Actually the whole of life CDC model is a pension accrual system. There never is a pot so it does not turn a pot into a pension. What it does is get people saving into a plan that produces a pension, the only pot being the big collective pot from which pensions are paid.

CDC does away with individual pots. The Royal Mail Collective Pension Plan does not have a transfer in facility (though it could have). So it cannot be said to turn DC pots into pensions either. The LGPS and several other ancient DB schemes that have appetite , still takes pots and pays out pensions (this from LGPS.member.org)

Your previous pension scheme will offer a sum of money called a transfer value. That transfer value would buy an amount of extra pension in the LGPS. Your request to investigate a transfer is not binding until you have seen an estimate of the amount of extra pension the transfer value would buy and confirmed that you want the transfer to go ahead.

The CDC model that turns DC pots to pensions has yet to be built. Experts call it “decumulation only”. Right now , if you want to turn your pot to a lifetime income and you aren’t in the LGPS (+ a few others DB schemes that pay pensions from pots) then you need to buy an annuity. The Government has yet to start encouraging savers to buy individual annuities.

John Ralfe’s tweet

While the Government is telling us that the Pension Schemes Bill will help us find ways to turn pots to pensions, the 2025 Finance Act looks limit the tax incentivisation that turns a pension into a pot. This looks consistent in policy terms.

But doing so will make pensions much less attractive to those who see pensions as a means of accumulating tax-free wealth. Infact , some high earners will stop using pensions and do other things with their money instead. This is John’s point.

But 80% of savers who have responded to a recent Scottish Widows survey, said they wanted a consistent lifetime income from their pension – not a pot. And while there will be a proportion of those who save who will have either £400,000 in their pot or a prospective pension of £20,000 pa or more, they are likely to mostly fall into the 20% of people who want the freedom to drawdown their wealth as it pleases them.

So we should qualify John’s comment , it relates to the lucky few people who have a potential problem with tax-free cash at £100,000. For the 80% who don’t – we need to find a way to turn pots to pension – whole of life CDC is too late for the estimated 650,000 people a year who find themselves with a pot but not pension.