Celebrity tax avoidance has been a hot topic lately and the government is moving forward with its General Anti-Abuse rule to clamp down on artificial and evasive tax-avoidance schemes. It is not designed to curtail the use of legitimate tax-advantageous schemes, so we can conclude that UK-registered pension schemes are not going to be outlawed.
It is worth remembering that for those earning in excess of £150,000 up to 50 per cent tax relief is available on pension contributions. From 6 April 2013 the top rate of tax will drop to 45 per cent, presenting a ‘buy while stocks last’ opportunity.
Counter-intuitive tax hike
This reduction in top rate tax is intriguing at a time when the exchequer’s revenue needs to be raised. Part of the rationale was that it appeared the 50 per cent rate had not raised as much income tax as expected and may actually have had a negative impact. Mathematically, raising the tax rate for a given size of income will yield higher tax receipts.
But if you factor in human behaviour, it appears there comes a point where the level of taxation is deemed unacceptable and people will find ways, legitimate or otherwise, of lessening their burden. The trick is finding the optimum rate that most people will find reasonable and therefore not warrant seeking to mitigate or pay expensive fees to avoid it.
The same criteria could also be applied to the taxation of benefits arising from pension savings. Although under the current capped drawdown facility the tax charge on lump sum death benefits is now 55 per cent (a welcome reduction from the maximum 82 per cent under alternatively secured pension) it has signalled an increase for those in drawdown prior to age 75, from 35 per cent to 55 per cent. This exacerbates the gap and apparent unfairness when compared with the zero rate on uncrystallised funds.
Even though the 55 per cent tax rate may be justified mathematically, and was supposedly a cost-neutral change, the question is whether it is perceived as fair to those already saving via a pension arrangement or being encouraged to do so.
The common rhetoric of politicians is that they want to support hard-working families. Saving for retirement means sacrificing income today that could otherwise have been spent on the nicer things in life. For this reason perhaps, many still find the thought of a tax on leftover pension funds on death unpalatable.
Income tax on pension income is not unreasonable – so is it this 55 per cent tax charge that affects the behaviour of those that seek to move their funds illegitimately through liberation or offshore via QROPS (Qualifying Recognised Overseas Pension Scheme), or shun pensions in favour of ISAs?
If so, allowing leftover funds following death to be transferred, free of tax, to a beneficiary’s own pension arrangement may be a clever move for the Treasury. On the face of it, mathematically, this would not be tax neutral for the exchequer, but looking at the bigger picture, could it yield more?
Win win
If leftover funds, built up through hard-sacrificed take-home pay, could be passed on to family members or other beneficiaries’ pensions in this way, perhaps this would curtail activity seeking to avoid more than half of that money going to the tax man. Ultimately it keeps more money in the UK pensions tax system on which income tax will at some point be applied.
It may also incentivise saving via a pension, with the knowledge that leftover funds can fully benefit the next generation. In addition it aids government policy by helping future generations have decent retirement provision and not be reliant on the state. Win win.
Robert Graves is head of pensions technical services at Rowanmoor Pensions
