Penny drops on tax impact of pension freedoms

The industry has at times seemed obsessed about whether people are too stupid and irresponsible to look after their own money.

Yet if there is one issue that is bound to make people think twice about taking all their money at once – it is tax.

It has been left to the consumer press to highlight this vital issue, which many pension providers and advisers have shown a marked lack of interest in.

The tax position certainly makes the much-debated option of taking the pension to invest in buy-to-let look a dubious prospect at best.

And it blows the chances of buying a Lamborghini right out of the window.

There are several areas that should concern investors and their advisers.

Those who have received only basic-rate tax relief on their contributions could pay higher tax on their pension withdrawals.

Some may pay a 60 per cent marginal rate on part of their pension as their personal allowance is stripped away.

Those on low incomes could see their savings interest taxed rather than benefiting from the £15,000 allowance.

A tax tangle will ensnare many as emergency rates are applied on withdrawals.

There is the prospect of exposing the previously ring-fenced money to inheritance tax.

And some could have state benefits cut or lose them altogether.

That is an awful lot to consider. Somehow I doubt the Pension Wise staff will be sufficiently knowledgeable to cover these topics adequately or accurately.

I asked Danny Cox of Bristol-based Hargreaves Lansdown to run some sums.

These showed that more than £43,000 of a taxable £75,000 sum could be snatched in tax if the circumstances were right – or should that be wrong.

All it would take is for someone with a reasonable salary of £50,000 to cash in a £100,000 pension while they were still working.

All it would take is for someone with a reasonable salary of £50,000 to cash in a £100,000 pension while they were still working.

Once the tax-free cash was taken the other £75,000 would thrust our investor through the £100,000 barrier and before they knew it they would be losing 60p in every £1 to tax as their personal allowance was whittled away.

The fact that emergency tax must be applied to withdrawals means most will be charged too much tax at the outset and must wait for a rebate, though a few could pay too little and get an unwelcome tax bill later.

But it is the IHT aspect that appears to be the most overlooked. As you no doubt know, a pension can be inherited and taken tax free if its owner dies before age 75.

Even if they died after the age of 75 the inheritor would only pay tax at his marginal rate on any withdrawals as long as he did not take it all at once.

By taking the pension now, that money would not only be taxed at withdrawal, it would also fall into the inheritance tax net.

Take a £100,000 pension. Someone would get £25,000 tax-free and might lose 40 per cent of the rest when they withdrew it – leaving £70,000 of the pension remaining.

In the worst case, if they died a few months later, a further £28,000 could go in inheritance tax leaving £42,000 to go to children and grandchildren.

The fact is that for many who have a pension, there is only one place their money should remain – and that it in their pension.

It is nothing to do with spending it too quickly or longevity – it is purely financial common sense.

_________________________________________________________________________________

... so who really benefits?

Strangely, I have not been able to find anything so far concerning a tax windfall for the government.

But with some estimates suggesting there is £5bn in 400,000 pensions waiting to be sorted out after April 6 I would be astonished if the Treasury were not expecting a little extra cash.

And it is not just here that the windfall could come. Just think of all that pension cash cascading down the generations and then being taxed when those who inherit it withdraw the money. Previously, this money would have disappeared into insurance company coffers – but now the Treasury will get a share.

There is also the prospect of some extra inheritance tax from those who withdraw pension cash and then die before they get a chance to spend it.

It is a canny strategy by the Tories which promises to bring substantial amounts of tax flowing in without complaint from those who are paying it.

Perhaps it might also silence those who complain the baby boomers have benefited from soaring house prices and investments while contributing nothing.

Tony Hazell writes for the Daily Mail’s Money Mail Section